BEATING YOUR OWN EXPERIENCE OF INFLATION
The latest inflation number in South Africa was at a very low, coming in at 2.8% year-on-year. This is the lowest inflation reading since June 2020 where we were in the grips of the Covid shutdown and constrained supply chains. In fact, South Africa seldom sees an inflation rate so low. Yet in our own personal experience we feel that prices are constantly rising. So why is the reported inflation so vastly different to our own experiences? In this month’s Financial View, we look at how inflation is calculated.
In South Africa our inflation is calculated by Stats SA (a national government department). They do this by calculating the Consumer Price Index (“CPI”). According to the Stats SA website CPI measures monthly changes in prices for a range of consumer products. Changes in the CPI record the rate of inflation. The CPI can also be used as a cost-of-living index.
The range of consumer products is often described as the basket of goods. Stats SA do acknowledge that different consumers spend money on differing things as they state, “The prices of goods and services consumed by South Africans are used to calculate an inflation rate for the whole economy. But not all South Africans consume the same goods or services, nor do they consume them in the same proportions. The CPI therefore cannot measure the way individual households experience inflation, or how they spend their money. As a result, the inflation rate is based on the estimated total expenditure of all South African households.”
So, the basket of goods can thus be described as how the average South African spends their income.
Using the latest CPI statistical release, we can plot the basket of goods in the following treemap.
We have highlighted the 4 largest categories in separate colours.
In green we have coloured all the sub-components that make up Food, Beverages & Tobacco.
The various sub-components constitute 23.40% of the basket. Overall inflation for this group is slightly above the annual inflation rate with the standout being hot beverages as anyone who has recently purchased coffee can attend to.
In blue we have coloured all the sub-components that make up Housing and Utilities.
The various sub-components here constitute 24.49% of the basket. At the moment this is the area that is providing the most upward pressure on inflation as electricity falls in this group. Electricity and other fuels constitute only 3.7% of the basket and have increased by 11.4% year-on-year.
In gold we have coloured all the sub-components that make up Transport.
Transport accounts for 14.35% of the basket and it is this group that has helped reduce headline CPI to where we are now. Fuel, which is directly linked to the price of oil, has been in freefall and has dropped by 19.1% compared to last year. Does this mean that petrol for example is cheap? The example is a resounding no, it just happens to be far cheaper than the equivalent point last year – but still high compared to historic prices for fuel. A large reason for this is the amount of taxes and levies that are included in the fuel price these days.
The last group that we have highlighted is in red and reflects insurance and because it’s on its own it only constitutes 9.89% of the basket. Insurance is also increasing quite quickly and providing upward pressures on CPI. Insurance is quite a broad category as it would include life policies, short term insurance policies and funeral policies.
Close to three quarters of the average South African’s spend goes to these 4 categories. We would argue that this basket is vastly out of line for every single one of our clients.
There are really 4 items that we think are underweight in the basket based on our own experience.
The first is health. Health constitutes just 1.44% of the official basket of goods. This is vastly different for any South African who is a member of a medical scheme. Medical scheme increases are close to double digits year on and year out. This expense is becoming a large component of the working and retired people in South Africa.
The second is education. Education is also relatively small at 2.62% of the basket. Anyone with children in any fee-paying institution, whether primary or tertiary, private or model-C environments will argue that to them it seems that all their income goes towards education.
We have already mentioned electricity. The proposed increases that Eskom have tabled are certainly going to place upward pressure on CPI in South Africa. Is it realistic that it is only 3.70% of our total spend. And if that number is relatively accurate at this point, it will not be realistic once the increases have been enacted.
The fourth component is security. This is not specifically listed within the inflation basket. Either it does not form part of the average basket, or it is included as a small component of the catchall sub-component of “Other goods and services”. Either way it is a miniscule expense for the average South African as represented by this basket.
As we have said previously – our lived experience is totally different. Each one of these items is a far bigger component in our personal baskets, but probably also yours. In fact, if you spend more than 8% of your income on these 4 items then you are like us. What makes this even worse is that, excluding electricity, these are items that we have already contributed towards by just paying our various taxes. It is thus clear that government inefficiencies such as corruption and ineptitude are inflationary themselves.
So why is inflation important?
We see inflation as a thief stealing the value of your investments as it reduces your purchasing power. In a simple explanation R100 buys you far less today than it did a decade ago. So, to maintain the purchasing power of your assets you need the value of your assets to grow by at least inflation (and we would argue that the growth should be at least that of your own experience of inflation, not the average South African’s inflation). In fact, to allow for an annual increase in your pension each year, your investment returns need to outperform the rate of inflation.
This means that one always needs to apply high thoughts and skills to portfolio construction. Asset allocation is of critical importance as you need exposure to growth assets, regardless of where you are on the risk curve. Equities are usually the best asset class that will give you a real return, being ahead of inflation. They will give you protection against inflation over the longer term as companies you are invested in can be price makers as opposed to price takers.
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