3 minute read
Explaining the base effect
By Simon Brown
We have seen this effect in the surge in inflation, GDP data and company results. But how do we work around it?
One of the new popular phrases being used within the investment world is “base effect”. For example, globally we’re hearing all about how the current surge in inflation is due to base effect. This is because a year ago we’d seen the price of Brent crude oil crushed (and even turn negative for West Texas Intermediate contracts). In addition, while being locked down nobody was out spending much, so last year’s inflation came under severe pressure. Now, a year later, that lower number is the base for calculating inflation and as such this year’s number spikes higher.
It is important to take this base into account. We’re seeing the base effect in company results too. Recently, Capitec* issued a trading update saying it is reasonably certain that headline earnings per share (HEPS) for the six months ending 31 August are expected to be more than 500% higher than for the same period a year earlier. This is in large part due to the base effect as the comparable period was under massive pressure and Capitec also included large provisions for bad debts.
So, that jump of 500% is skewed by a lower base and in this case also by the provisions that they made and didn’t need. Hence, Capitec return these back into the business via the income statement, which boosts HEPS.
The problem is how do we work within this base effect? One easy way is to compare the results against an earlier period; in the case of Capitec it can be the period ending in August 2019 (which was before the Covid-19 pandemic struck). This is easy enough, but we then have to be careful as this way of working glosses over the impact of the pandemic and the reality is that Covid-19 did happen and it did impact results.
Staying with Capitec, we can also deconstruct the results when they arrive. Removing the unused provisions from both last year and this year will help. With economic data such as inflation and GDP it is harder to do. I’ve been referring to our return to economic output prior to the pandemic and what we can do as an alternative measure. Stats SA puts our total GDP at R782bn for the quarter ending March 2020, just as we went into hard lockdown. At the end of the first quarter of 2021, local GDP was estimated at R761bn. So, a year after the pandemic started our economy is 2.6% smaller. As an aside, that’s a lot better than I would have expected a year ago. The recovery has been fast.
What we also need to prepare ourselves for is the same base effect talk in a year’s time. Then we’ll have the high base, especially with inflation, and this will skew the 2022 numbers downwards due to that higher 2021 base. This won’t be as stark within GDP but will also manifest within company results.
Staying with Capitec, what we’ll see is August 2022 mid-year results not as rosy as this year’s results.
So, we’re going to have skewed data until probably the end of next year as the impact of the lockdown works its way through the system. In some data sets the pandemic has forever skewed the charts, with US unemployment being perhaps the best example. Previous worst initial jobless claims had peaked at around 800 000 in the global financial crisis of 2008/2009. Yet, last year they hit about 7m and that chart will forever have this insane spike that makes all the other data essentially look like a flat line. ■
editorial@finweek.co.za *The writer owns shares in Capitec.
