To See Through Big Numbers, Just Do Small Math

Whenever there is news coverage of events with a financial impact, we see big numbers. The Australian wildfires are estimated to have caused A$4.4 billion in damages so far.ⁱ Germany’s budget surplus hit €13.5 billion in 2019.ⁱⁱ Italy has to sell €50 billion worth of new sovereign debt this year.ⁱⁱⁱ Despite a recent trade agreement, new tariffs will still cover $360 billion worth of US imports from China.^iv But how meaningful are these numbers for investors trying to make sense of current events? We think there is a simple tool people can use to cut through the noise and assess whether these seemingly big numbers are actually so big, relatively speaking. It is called scaling.

Scaling, simply, refers to turning a raw number into a percentage of a larger, related whole. For example, calculating the cost of a natural disaster as a percentage of gross domestic product (GDP, a government-produced estimate of economic output) can help investors estimate whether the actual economic impact will be large or small. Calculating tariffs as a percentage of US or global GDP can do the same. Measuring bond issuance as a percentage of currently outstanding debt can give a sense of whether the increase is really big…or small.

We can use this approach for all of the figures mentioned earlier. For instance, Australia’s GDP in 2018 (the most recent full year available) was A$1.9 trillion.^v The fires are clearly a tragedy, but the A$4.4 billion estimated cost is just 0.23% of output—in our opinion, this is unlikely to disrupt national economic activity. In our view, that pushes economic and/or market fallout far down the list of concerns tied to the events. What about Germany’s surplus? German GDP totalled €3.34 trillion in 2018 (the most recent year available).^vi The €13.5 billion surplus represents just 0.4% of this. We think that is a counterpoint against pundits’ claims that spending this surplus would generate a big economic stimulus to lift the country out of its recent economic malaise—0.4% of GDP just isn’t large enough to have a huge effect, in our view.

What about Italy? Will that €50 billion in planned new sovereign debt issuance this year overload investors, causing financing problems for what many view as an unstable government? At 2019’s end, there was just over €2 trillion in outstanding Italian debt securities.^vii €50 billion in net new issuance represents a 2.5% increase over that amount—hardly an avalanche. If anything, we suspect investors who crave higher-yielding debt will welcome it as an alternative to rock-bottom sovereign yields in Germany, France and elsewhere in the eurozone.

Putting US tariffs in perspective uses similar math but requires two calculations. Calculating the $360 billion in goods subject to tariffs as a percentage of US or global GDP won’t yield the desired result, as the goods themselves aren’t the direct cost. Rather, the cost is the tariffs paid on those goods. The tariff rates vary from 7.5% to 25%. To err on the side of caution—and allow for tensions to ratchet up—we like to overestimate and assume a 30% tariff rate across the board. Applied to $360 billion in imports, this would result in maximum US tariff payments of $108 billion. This is still a large number. But US GDP was $20.58 trillion in 2018 (again, the latest available).^viii Tariff payments represent just 0.5% of this. Add in all existing and threatened tariffs between the US, China, the EU and other trading partners, and total payments amount to just 0.4% of the International Monetary Fund’s (IMF) latest estimate of 2019 global GDP, which is $86.6 trillion.^ix

In our view, there is another important area where scaling can help: measuring equity market returns. When financial pundits cover equity markets like Germany’s DAX, France’s CAC 40 and the Euro Stoxx 50, they often report market movement in index points. For instance, the CAC 40’s price level rose 1,247.36 points last year, the second-highest annual increase since the index formed at the end of 1987.^x Only 1999’s 2,015.66-point increase was larger.^xi But was 2019 really the second-biggest year on record? As indexes rise over time and their price level becomes higher, a given point-based movement represents a steadily smaller percentage increase. In percentage terms, the CAC 40 rose 26.4% last year.^xii That is far smaller than 1999’s return, 51.1%.^xiii But it is also smaller than in 1998, when the index returned 31.5% whilst rising just 943.75 points.^xiv It also trails 1997, when a 683.18-point rise translated to a 29.5% price return. In 1989, a 427.14-point increase amounted to a 27.1% return.^xvi The index’s best year, 1988, was a 57.4% return—and only a 573.94-point rise.^xvii

Scaling big numbers won’t magically make anyone a perfect investor—perfection is impossible. But being able to put large numbers in context can help you assess whether a development—either seemingly good or bad—is really as significant for the economy or markets as financial pundits might suggest. We think this can help build a better foundation for sound portfolio decision making.

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