How to spend and invest in the consumer sector

2020-11-25 15:56 Minggao SHEN

AnnexHow to spend and invest in the consumer sector [republished].pdf

Consumer spending key to China's economic growth Amid sluggish external demand due to the global economic downturn and escalating China-US trade frictions, China needs to keep supporting its production expansion with growth in domestic consumer spending. Its economic model is shifting from a traditional production-driven one to a high-level one with a better balance between production and consumption, and even to one that is driven by consumer spending.

Historically, major economies dominant in the global consumer market have been able to dictate global economic growth Growth has been soft in economies such as the US and Europe which are reliant on the traditional consumer sectors. The expansion in China's consumer spending will not only help to stabilize economic growth in the country, but also have a profound impact on the global economic recovery and development.

Six characteristics of consumer spending in China

First, growth in the consumer discretionary sector has been slower than in the consumer staples sector, meaning China’s rapid economic growth is yet to be reflected in consumption growth, and is yet to improve the structure of consumer spending.

Second, the pandemic has delivered a blow to discretionary spending. In 1Q20, YoY growth in China's consumer discretionary sector was nearly 29pp slower than in the consumer staples sector.

Third, discretionary spending is more elastic than staples spending to income. The slowdown in discretionary spending has been a reflection of expectations and worries among Chinese consumers of a potential decline in income, but the upside in discretionary spending is greater when the economy improves on a QoQ basis.

Fourth, the structure of consumer spending is closely related to a country’s stage of economic development. On the whole, most consumer spending in emerging markets is on consumer staples, while consumers in developed countries mainly spend on discretionary items. With household incomes rising, growth in discretionary spending will gradually outpace staples spending, and make up the majority of consumption.

Fifth, YoY growth in discretionary spending is a leading indicator of China's GDP growth. Consumers tend to ramp up discretionary spending when they expect the economy to grow, and vice versa.

Finally, the pandemic may have led to inflation in food prices. Unlike previous shocks that hit incomes, the pandemic has affected the economy through lockdowns, which have had negative effects on both supply and demand. When the pandemic was initially brought under control, spending on consumer staples recovered at a faster pace, resulting in a faster rebound in food-related CPI than in non-food CPI.

Structurally, discretionary products that belong to consumer staples (catering and retail) and essential goods that belong to consumer discretionary (financials, pharmaceutical, communications and sports) will benefit directly from China's economic transformation, and should be favored by long-term investors.

Risks: Changes in the macro economy exceed expectations, consumption upgrades miss expectations.

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