The Economy Probably Shrank 2% Last Quarter and it Doesn't Matter

The Commerce Department this week will release new revisions to first-quarter GDP. The numbers will probably look very ugly, but it doesn't matter for stock investors.

Jun 23, 2014 at 1:00PM
Take The Long View

The Dow Jones Industrial Average (DJINDICES:^DJI) was down 29 points at 1 p.m. EDT, still hovering just above 16,900 points. The 0.18% decline came as the U.S. weighs providing energy lifelines to countries like Ukraine that rely on exports from Iran and Russia, while Iraq falls further toward civil war. 

With the seemingly never-ending chaos abroad, the Commerce Department is scheduled on Wednesday to release the latest update to its first-quarter U.S. gross domestic product estimate.

Unfortunately, expectations are for a very ugly number.

From unchanged to -1% to...
The department's initial estimate two months ago was more or less stagnant growth. Economists thought the economy fought through the cold winter and maintained productivity. Nothing gained, but nothing lost.

That all changed as exports disappointed while inflation remained subdued. The first revision moved estimated GDP down a full 1%. 

Analysts today expect the second revision to show the economy shrank by about 2%. This would be driven by sharply reduced spending in the health-care sector, which trickles through to lower private consumption. The end results is a major drag on GDP. 

If this estimate proves accurate, this will be one of only a handful of quarterly declines of more than 2% since 1947. 

US Real GDP Growth Chart

US Real GDP Growth data by YCharts.

What does this mean for stocks?
The stock market is a forward-looking entity. Investors care little for what happened yesterday. What matters is what will happen tomorrow.

In that light, first-quarter GDP is old news. A downward revision to economic estimates from two months ago is not pertinent at all -- no corporation is going to restate first-quarter results, released weeks if not months ago, because of the Commerce Department's report on Wednesday.

As an equities investor, the simple microeconomic factors impacting a business are much more significant than the macro. 

Don't ask yourself if the economy is growing fast enough (or, perhaps, not shrinking too much). Instead, think about the specifics for the companies in which you invest. Is the customer base adopting that new product? Is management effectively controlling costs and running an efficient operation? Is a competitor stealing market share and hindering revenue growth? Is the stock price today over, under, or accurately valued based on the business's earnings and return on capital? 

A real-life example to illustrate the point
This chart shows the percentage change in the Dow, the S&P 500 (SNPINDEX:^GSPC), and megabanks Wells Fargo (NYSE:WFC) and Bank of America (NYSE:BAC) from January 1, 2006, to today.

WFC Chart

WFC data by YCharts.

Wells and Bank of America are both gigantic banks that experienced the exact same macroeconomic circumstances. The financial system nearly collapsed, while millions were losing jobs and falling behind on their mortgage payments. The foundations of the industry were crumbling.

And yet, from the highs of pre-recession 2006 to today, Wells Fargo has trounced Bank of America and the markets in general. The bank has beaten both the S&P and Dow by over 10%, and the comparison with Bank of America's performance is laughable.

If you were paying attention primarily to the macroeconomic environment, you would missed out on Wells' market-beating performance. However, a focus on the microeconomics would have foretold why Wells still presented a compelling long-term investment. Let's break it down.

Wells And Big Building

Wells sets the standard for credit culture. For decades it has avoided the deepest downfalls simply because it makes only high-quality loans -- the kind of loans that generally still are repaid when the macroeconomy takes a turn for the worse. 

Wells runs a simple, efficient operation. Compared to many of its peers, its balance sheet and business model are downright pedestrian. And that's a good thing! Investors know what they get when they buy Wells Fargo. There is no black box of dangerous derivatives contracts or outrageously risky real-estate loans.

Whatever the macroeconomic situation, Wells Fargo is likely to beat its competitors. The reason is simple: macroeconomics don't matter for investing in individual stocks. Focus on the fundamentals of microeconomics and value investing. That's the recipe for beating the markets.

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Jay Jenkins has no position in any stocks mentioned. The Motley Fool recommends Bank of America and Wells Fargo. The Motley Fool owns shares of Bank of America and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

A Financial Plan on an Index Card

Keeping it simple.

Aug 7, 2015 at 11:26AM

Two years ago, University of Chicago professor Harold Pollack wrote his entire financial plan on an index card.

It blew up. People loved the idea. Financial advice is often intentionally complicated. Obscurity lets advisors charge higher fees. But the most important parts are painfully simple. Here's how Pollack put it:

The card came out of chat I had regarding what I view as the financial industry's basic dilemma: The best investment advice fits on an index card. A commenter asked for the actual index card. Although I was originally speaking in metaphor, I grabbed a pen and one of my daughter's note cards, scribbled this out in maybe three minutes, snapped a picture with my iPhone, and the rest was history.

More advisors and investors caught onto the idea and started writing their own financial plans on a single index card.

I love the exercise, because it makes you think about what's important and forces you to be succinct.

So, here's my index-card financial plan:


Everything else is details. 

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