GDP

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When markets (temporarily) give more value to the earnings of one company, Nvidia, than on indicators of economic health, something is skewed. Earning in general follow the economy, not the other way around. One of the main factors to measure economic momentum is the gross Domestic Product (GDP). This is the monetary value of final goods and services—those purchased by the end user—produced within a country's borders during a specific period. GDP growth is a key indicator in determining whether a country has entered a recession. According to the U.S. National Bureau of Economic Research, a recession is defined as "a significant decline in economic activity spread across the economy, lasting more than a few months, typically visible in production, employment, real income, and other indicators." A recession begins when economic activity peaks and ends when it reaches a trough. While there are various definitions, the most widely recognized benchmark for a recession is two consecutive quarters of declining GDP. Since a healthy economy typically grows over time, two consecutive quarters of negative growth suggest underlying economic challenges.

Recessions can stem from various causes, including sudden economic shocks, excessive debt, asset bubbles, inflation, deflation, and technological change. A sudden economic shock is an unexpected event that disrupts financial stability, such as the 1970s OPEC oil embargo, which triggered a recession by restricting U.S. oil supplies. More recently, the coronavirus pandemic caused a global economic shutdown, demonstrating how shocks can rapidly destabilize economies.

?Excessive debt is also a common recession driver. When individuals or businesses accumulate unmanageable debt, defaults and bankruptcies can rise, destabilizing the broader economy. The mid-2000s housing bubble, which led to the Great Recession, exemplifies how unsustainable debt levels can precipitate economic downturns. Asset bubbles occur when investors drive prices beyond sustainable levels due to irrational optimism. Alan Greenspan famously termed this “irrational exuberance” during the 1990s stock market boom. When these bubbles burst, panic selling ensues, often leading to recessionary conditions.

Inflation, the continuous rise in prices, can become problematic when it escalates uncontrollably, prompting central banks to raise interest rates to control it. However, higher rates can suppress economic activity, as seen in the 1970s when the U.S. faced high inflation and subsequent recession. Conversely, deflation—falling prices—can also lead to recession by reducing wages and stifling spending and investment. Japan’s prolonged deflation in the 1990s is a notable example of how persistent price declines can weaken an economy. Finally, technological changes, while beneficial in the long term, can disrupt labor markets and contribute to short-term recessions. The Industrial Revolution displaced many workers, leading to economic downturns, and concerns persist today that advances in artificial intelligence and robotics could similarly disrupt job markets, potentially causing future recessions.

The U.S. economy has consistently outperformed the European economy, with few exceptions. As the chart above illustrates real GDP, inflation must be considered as a contributing factor. Following the pandemic, Europe experienced a surge in inflation driven largely by rising energy prices, exacerbated by the Russia-Ukraine conflict. This inflationary pressure partly accounts for the lower valuations of European equity markets compared to those in the United States.

Comparing countries' growth rates with their expected price/earnings (P/E) ratios reveals that two countries stand out: India and China. The relatively higher valuation of the S&P 500 index, particularly in its non-equal-weighted form, can be attributed to the United States' consistently higher growth rates. This superior growth is driven by several factors, including robust productivity gains and significant government expenditure.