Explaining the base effect

We have seen this effect in the surge in inflation, GDP data and company results. But how do we work around it?

- Simon Brown

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.