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

The Dow Jones Industrial Average 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 , and megabanks Wells Fargo and Bank of America 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 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.

These stocks beat the big banks...
Here's your chance to pocket big dividends. Over time, dividends can make you significantly richer. And guess what? The big banks are laggards when it comes to paying dividends. So instead of waiting for a cash windfall that may never come, check out these stocks that are paying big dividends to their investors RIGHT NOW. Click here for the exclusive free report.

The article The Economy Probably Shrank 2% Last Quarter and it Doesn't Matter originally appeared on Fool.com.

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.

Copyright © 1995 - 2014 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.


Increase your money and finance knowledge from home

Investing in Emerging Markets

Learn to invest in a globalized world.

View Course »

What Is Your Risk Tolerance?

Answer the question "What type of investor am I?".

View Course »

Add a Comment

*0 / 3000 Character Maximum