S (and) P/TSX INDEX VERSUS DOWJONES INDUSTRIAL AVERAGE AND LET’S ADD INFLATION!Ian Whiting
It has been said that there are Liars, Damn Liars and Statisticians – and you can throw in Economists for good measure! Another approach is to ask a mathematician, an accountant and an actuary the result of the formula 2 plus 2 equals what? The mathematician will say 4, the accountant will say that depends (explains a lot about some financial reporting!) and the actuary will ask, what do you want it to equal? Through creative choices, numbers can be made to say just about anything a person desires, if you apply enough “logic” – no matter how flimsy!
Apples to bananas! As we explore the effects of growth rate assumptions on financial, estate and insurance planning, I am going to take a slight detour to briefly discuss two benchmarks commonly in use – the most popular being the S&P/TSX – which is an INDEX, and the DJIA which is an AVERAGE – they are NOT interchangeable nor do they measure the same things!
The DJIA measures the 30 largest (by market cap) US Corporations – subject to annual reviews and adjustments. The S&P/TSX measures (allegedly) the 300 largest (by market cap and not necessarily purely Canadian) companies trading on the TSX. At last count, there are apparently about 290 companies included in the S&P/TSX Index. Finally, one is expressed in CDN currency and the other in US currency so variations in the DJIA, as usually seen in Canada, also reflect exchange rate movements.
As you can see, the DJIA is only a very narrow “measurement” of market value and movement while the S&P/TSX is, at least in theory, a reflection of a much broader market. Very different measurements yet for some reason they are entwined as being very similar, if not identical – and not just by the media, many in the financial services industry are also guilty of this “grouping” for comparison purposes.
The closest US market measurement to the S&P/TSX Index is the S&P 500 Index – as the name implies, measuring the movement of the largest 500 US Companies – also in US Currency and then converted to CDN $ for use here – again adding exchange rate movements to the changing index values.
Many people are unaware that we (Canadians) do have a “large cap” index that is SIMILAR, but not identical to the DJIA – it is the TSX60 – which measures the 60 largest companies trading in Toronto. So, if comparisons about movements, trends, etc. are to be made, it is certainly far more appropriate to compare movements (net of currency exchange effects), between the DJIA and the TSX60. Other major exchanges around the world also have narrower, large cap sub-indices similar to the TSX 60.
For more specific information about the compositions of the various indices and market averages, please refer to their specific websites – or have fun with Wikipedia.
Inflation has been around since someone started to track changes in prices of various goods and services. In Canada, we use the Consumer Price Index as measured by Statistics Canada. All details can be found on their website plus additional information on Wikipedia. Obviously, the basket of “goods and services” in use today is very different than 50 years ago – even 20 years ago – consumer choices and options change – therefore so does the “basket”. In Canada, inflation is separated into a “full measure” of everything and then a variety of sub-indices such as “core” inflation along with others such Health Care, Education, Recreation, etc.
Comparisons between inflation rates amongst various countries is close to impossible – each country is measuring different items, then of course, we may have currency issues that could also affect published rates – check the websites for each country to determine how currency may impact published results.
All too often, people in our industry and in some cases the media, tend to use a single inflation assumption in our planning – which is patently incorrect. When people retire, the effects of inflation are typically higher due to probable higher costs for Health Care and Recreation, while some aspects of the total inflation rate will drop such as business transportation.
I will discuss inflation in planning in more detail in a future blog – my only purpose here is to caution people to be careful about your chosen basis for assumptions during different phases of the planning process – different rates for education costs, health care, recreation, housing, etc. are all appropriate – a single presumption is not!
BTW, I watch Business News Network each morning to catch Marty, Frances and Michael plus their various guests – plus I regularly use their website – www.bnn.ca – for other updates and information on various indices – including the TSX60.
Posted: June 18th, 2012 under Asset Allocation, Cost of Living, Estate Planning, Finance, Financial Planning, General, Government, Insurance, Investments, MONEY®, Mutual Funds, Personal Finance, Saving, Software, Taxes.