Opportunities in consumer-related sectors

Domestic demand the biggest growth driver

The equity markets started the year on a false note. Although China and the weak oil price are the biggest culprits, they’re not the only ones. Weak US industrial stats and poor bank sector results also contributed to the weak performance. A global shift to the services economy offers, in this context, opportunities in the consumer-related sectors.

The tough start experienced by the equity markets stems above all from a number of uncertainties that (nonetheless) do not directly detract from the equity-friendly macro-economic scenario. Accordingly, economic growth in the US, despite disappointing industrial figures, remains solid while accelerating in the Eurozone thanks to the low oil price, the weak euro, better credit conditions in the peripherals and a more flexible fiscal policy. Economic growth is, however, less driven by industry, which is having to yield ground to services sector growth in the US and China and elsewhere.

Consumer underpinning economic growth

Following the recovery in the aftermath of the Great Recession of 2008-2009, economic growth is once again underway. Current cyclical indicators show further growth in GDP and controlled inflationary pressure.

In the US, the economy has exceeded its performance of 2007. In recent quarters, consumption in particular has been the biggest growth driver. Not only is unemployment in the US strongly down, but US households’ purchasing power, too, has risen significantly in recent years. Although this is certainly due in part to the fall in the oil price, rising salaries will be equally influential over the coming months.

In the Eurozone, the services sector is also gaining ground. Because of the double-dip recession that followed the debt crisis, the economy, while still clearly lagging the United States, is fast making up the lost ground. The recovery is being driven foremost by consumption. The consumer is still benefiting from the low oil prices, the gradual drop in unemployment figures and the low inflation governing consumption prices. In addition, the healthy state of companies should also boost domestic demand.

Rebalancing of the Chinese economy

This trend has been particularly noticeable in China, where the corporate environment of a services-oriented economy is shifting to one that is more industry-driven. Consequently, from a global perspective, GDP is now less reliant on industry, in light of a services sector that is driven particularly by domestic demand.

Despite economic growth in China slowing to under 7%, its lowest level since 2009, we see that services and consumption, for the first time ever, account for more than half of China’s GDP (51.4%, as opposed to 41.4% a decade ago, according to CEIC and World Bank figures). This is an important milestone for the re-balancing of the Chinese economy, which is being driven in particular by the Chinese consumer, which, in the first three quarters of 2015, accounted for around 58% of economic growth (source: National Bureau of Statistics).

Over the next few years, Chinese consumption will, in addition, continue its upward trend, in line with the increase in income, the most supportive factor. In Q1 2015, real available income was up per capita by almost 8%. The increase is partly due to the greater overall prosperity, for which government policy is also partly responsible. One consequence has been an increase in the minimum wage in Shanghai over the last 10 years of more than 150% (source: Tradingeconomics, Ministry of Human Resources and Social Security).

Expanding middle class

The rise in global earnings and drop in absolute poverty levels portends a dramatic increase in the global middle class over the next few decades. In 2009, OECD figures classified 1.8 billion people as “middle-class”, a trend that the OECD sees as ongoing, leading to an increase, by around 2030, to almost 5 billion people. The strongest growth is expected in Asia (66% of growth versus 28% in 2009). This middle class will not only contribute to economic growth; it will, too, as a key driver of consumption and domestic demand.

Urbanisation supporting future consumption

Consumption will also increase further in countries other than China over the next few years. In a recent study carried out by McKinsey Global Institute (Urban World: Cities and the rise of the consuming class), it was reported that global urbanisation will result a worldwide increase in household income. In the cities, a further billion people is expected to join the “consumption class” around 2025. This class, with its relatively high income, will be a prolific consumer of goods and services. McKinsey Global Institute expects the urban consumer to be spending, by 2025 or so, a further massive 20 trillion dollars in the global economy. That will lead to a major increase in demand both for basic consumer goods & services as well as for luxury goods & services.

Big brands dictating pricing policy

Those investors wishing both currently and in the longer term to benefit from global consumption trends would be best advised to put some of their eggs in consumer-related sectors and companies. This could represent an opening for companies active both in Consumer Staples (food & beverages, household and personal products, retail) and in Consumer Discretionary (automobile sector, luxury goods, consumer services, media and retail).

However, to be able to benefit in a sustainable way from the global consumption spurt, independently of the economic context, preference should be given to the big brands and their price-setting powers. Indeed, only such brands, with their lion’s share of the market, can independently raise their prices. In addition, the profitability of the top brands (as measured by gross and net margins) is often significantly higher than that of the broader consumer sector (see table).

Also in 2015, the big boys (brand-wise) – despite (a) slightly disappointing of turnover-related organic growth in China as a result of the slowdown, (b) the terrorist threat and (c) currency volatility – were able to pleasantly surprise investors with sound earnings growth or rising share prices.

Conclusion

The growth of the global middle class as well as the possible resultant consumer growth should act as a huge long-term incentive for consumer-related sectors and companies. In the short term, too, however, investors could benefit from consumer growth by opting for strong companies that, market context apart, boast a handsome bottom line and potential rising stock value. Companies like Nike, Estée Lauder, McDonalds and Unilever currently top this list thanks to their strong brand and price-setting policy, organic growth and, especially, their widespread visibility as regards turnover and earnings expectations.