As inflation worries continue to dominate discourse within the markets, we dive into how inflation is calculated.
Diving into Inflation
Inflation continues to be a topic of discussion, whether it is around the dinner table, or when analysing the potential moves in global markets. I decided to take a look at what constitutes the inflation baskets both in South Africa and America to try and understand what moves the inflation numbers.
Before I dive into that, it is important to remember what inflation actually is: the number is a percentage change on what the prices in the basket were a year ago. The basket is an index of goods and services and each month it is recalculated and the price difference is calculated month on month, but the inflation percentage that is published is calculated on what the price of that index was twelve months before. Remember too that inflation is cumulative, so a 4% increase from last year (in South Africa) is on top of the 4% the year before that.
It is no wonder then that as administered prices like electricity, or property rates go up by 10 – 15% per annum they quickly pinch the monthly cashflow on a person’s budget!! And they don’t count for very much in the basket!
So what makes up the inflation basket:
What is interesting is if we break down some of the bigger components:
Looking at transport, which makes up 14.28% of the basket, the cost of new vehicles makes up 6.12%, fuel makes up 4.58% and other running costs make up 1.28%. So the cost of fuel, which we think is a big influence on the basket only makes up 4.58% in total.
Housing and utilities makes up 24.62% of the basket. The main component of this sector is owner’s equivalent rent which is 13.32%. Water makes up 3.16% and electricity makes up 3.8%.
Food and beverages makes up 17.24% of the basket. The numbers here are bit murky, but processed food contributes 8.67%, meat makes up 5.46% and breads and cereals 3.21%.
The last big contributor is Miscellaneous Goods and Services which is 15.05% of the basket, and a whopping 10.06% of that is insurance. The other components are personal care (2.12%), financial services (1.53%) and “ other goods and services” (1.34%).
The US inflation basket is much more detailed. They start with three levels – Food, Energy and all items less food and energy. Food makes up 14% and Energy 7% and the other items make up 79% of the basket:
Looking one level down on the All Items less food and energy portion:
The third level – looking only at the largest component which is Shelter:
And some of these sectors go down to eight levels!! You can work out what the change in the price of a lettuce, tomato or haircut costs! Or (if it’s important to you) the cost of underwear, sleepwear, swimwear or accessories!
You will often see the US inflation quoted excluding energy and food – which to me makes very little sense, given that those are the items that are used most frequently and have the biggest impact on a person’s cash flow! After all, I’ve never heard of anyone buying a new vehicle every month although it makes up 3.8% of the transport commodities sector.
The last thing that I want to leave you with is that however it is calculated, inflation is quoted as an annual rate of change, but is cumulative. The chart below shows that even though inflation in America has been quoted at around 2% for most of the last ten years, it creeps up to an increase of 20% cumulatively over that time, and if your investments don’t keep pace or exceed inflation, it is a quite killer of the ability to maintain a lifestyle!
Asset Class Returns
The table below represents a rolling year view of the major asset class returns that we track. It offers a view of the asset classes we use to diversify your portfolio.
Diving into Inflation
Inflation continues to be a topic of discussion, whether it is around the dinner table, or when analysing the potential moves in global markets. I decided to take a look at what constitutes the inflation baskets both in South Africa and America to try and understand what moves the inflation numbers.
Before I dive into that, it is important to remember what inflation actually is: the number is a percentage change on what the prices in the basket were a year ago. The basket is an index of goods and services and each month it is recalculated and the price difference is calculated month on month, but the inflation percentage that is published is calculated on what the price of that index was twelve months before. Remember too that inflation is cumulative, so a 4% increase from last year (in South Africa) is on top of the 4% the year before that.
It is no wonder then that as administered prices like electricity, or property rates go up by 10 – 15% per annum they quickly pinch the monthly cashflow on a person’s budget!! And they don’t count for very much in the basket!
So what makes up the inflation basket:
What is interesting is if we break down some of the bigger components:
Looking at transport, which makes up 14.28% of the basket, the cost of new vehicles makes up 6.12%, fuel makes up 4.58% and other running costs make up 1.28%. So the cost of fuel, which we think is a big influence on the basket only makes up 4.58% in total.
Housing and utilities makes up 24.62% of the basket. The main component of this sector is owner’s equivalent rent which is 13.32%. Water makes up 3.16% and electricity makes up 3.8%.
Food and beverages makes up 17.24% of the basket. The numbers here are bit murky, but processed food contributes 8.67%, meat makes up 5.46% and breads and cereals 3.21%.
The last big contributor is Miscellaneous Goods and Services which is 15.05% of the basket, and a whopping 10.06% of that is insurance. The other components are personal care (2.12%), financial services (1.53%) and “ other goods and services” (1.34%).
The US inflation basket is much more detailed. They start with three levels – Food, Energy and all items less food and energy. Food makes up 14% and Energy 7% and the other items make up 79% of the basket:
Looking one level down on the All Items less food and energy portion:
The third level – looking only at the largest component which is Shelter:
And some of these sectors go down to eight levels!! You can work out what the change in the price of a lettuce, tomato or haircut costs! Or (if it’s important to you) the cost of underwear, sleepwear, swimwear or accessories!
You will often see the US inflation quoted excluding energy and food – which to me makes very little sense, given that those are the items that are used most frequently and have the biggest impact on a person’s cash flow! After all, I’ve never heard of anyone buying a new vehicle every month although it makes up 3.8% of the transport commodities sector.
The last thing that I want to leave you with is that however it is calculated, inflation is quoted as an annual rate of change, but is cumulative. The chart below shows that even though inflation in America has been quoted at around 2% for most of the last ten years, it creeps up to an increase of 20% cumulatively over that time, and if your investments don’t keep pace or exceed inflation, it is a quite killer of the ability to maintain a lifestyle!
Asset Class Returns
The table below represents a rolling year view of the major asset class returns that we track. It offers a view of the asset classes we use to diversify your portfolio.