PEZ - Can Consumer Stocks Keep Their Momentum In 2024 Even Amid Recession Fears?

2023-12-23 04:20:00 ET

Summary

• The outlook for consumer discretionary in 2024.
• What a rate cut could mean for retail.
• How healthy is the consumer?
• The resiliency of the consumer has been one of the standouts of the economy this year, helping to push discretionary stocks higher.

The resiliency of the consumer has been one of the standouts of the economy this year, helping to push discretionary stocks higher. Can that trend continue in 2024 as concerns mount about slowing growth? Jacky He, Vice President of Portfolio Research at TD Asset Management, discusses the health of the sector with MoneyTalk’s Greg Bonnell.

Transcript

Greg Bonnell - Consumer stocks have had a pretty good run this year, but now we're seeing growing signs that shoppers are feeling the pinch of higher borrowing costs. So what will the consumer discretionary space look like in 2024? Joining us now to discuss, Jacky He, Vice President of Portfolio Research at TD Asset Management. Jacky, great to have you back on the program.

Jacky He - Thank you very much for having me.

Greg Bonnell - So we're on the cusp of 2024, as we said. The consumer discretionary names have had a fairly good run this year. Let's start with the year that we've had. What were the drivers?

Jacky He - It's very interesting. If you recall, the last year when we sat here talking about the sector outlook, consumers were really facing the challenge of high inflation and we were right in the middle of rate hiking cycle. So you saw the earnings expectations and PE multiples, both contracted negatively. So you look, that combination was historically rare, even during the global financial crisis. And then fast forward a year later, we saw the sector deliver 40% return. Thought about, oh, Amazon ( AMZN ) has done? No, excluding them, we still get about 20%. Not bad, right?

So the reason is really because of the low expectation allow the companies to beat earnings expectations throughout the year. And also important to remember, yes, you mentioned the consumer did feel the pinch. But they simply -- they did not stop spending. They simply shift from one category to another. So at the aggregate level, earnings was pretty solid.

Greg Bonnell - Okay. So defying expectations. As we head into 2024, the expectation investors in the markets are bringing into the year is that the Federal Reserve, the Bank of Canada, other central banks are going to start cutting rates. What does consumer discretionary look like in an environment like that?

Jacky He - Yeah. That's quite interesting. I think it's better to visualize that. The first chart I brought in is quite important. If you look at those shaded area, that shows the historical easing cycle. And the green line shows the relative performance. And you find, historically, the sector tends to underperform leading up to the first rate cut. And during the easing cycle, the sector outperformed significantly.

Why? Because this is really a leading sector that has higher labor intensity, has a higher cost of capital. So when rate is high, it's really costly to run those businesses. So the stocks tend to trade at lower earnings and lower multiples together. So a reversal of that trajectory can give support on both ends.

And if you look inside the sector, there still about 70% of stocks that are trading below historical averages. So for long-term investors, I think it's a good place to shop for opportunities next year.

Greg Bonnell - Yeah. There're some opportunities there to take a look at. What about the consumer themselves? I mean, in the end, these stocks will either make gains or pull back based on consumer behavior. We've had a pretty interesting, let's say, to put it mildly, three or four years now in terms of consumers. Has the behavior changed? What do we expect of next year?

Jacky He - Yeah. It's interesting. Consumers, no doubt, are directionally weakening. You hear from the companies. And you can look at delinquency rates. The problem is, almost everyone knows that. And now the bigger question is whether consumers will fall off a cliff from here, even in a recession or not.

So I think as a consumer, I care less about those economic terms, deflation, disinflation. All I care about is how much this item cost me today versus yesterday and how much I'm making today versus yesterday. If I can chart those two things and see how they have changed since the pandemic, you can see consumers have been through three phases of spending. At the beginning, when inflation was benign and we still received government stimulus checks, a lot of those money went straight to people's bank account. And last year, when inflation caught up with income, consumers started to feel that pinch. So they started funding their purchases with the savings.

And now, as those savings are being depleted, you start seeing the consumers' buying power started to recover, thanks to a strong labor market, thanks to a lower commodity cost. And if those things continue in 2024, it's probably hard to see consumers collapse. But I can certainly see consumers remain selective and continue to be price-sensitive.

Greg Bonnell - Yeah, we're showing the viewers that chart. It's a pretty telling one. I mean, structurally longer term as we go forward, even beyond next year, what should we be thinking about this, as investors, if we're taking a look at the consumer space?

Jacky He - Yeah. I think under the surface of solid earnings, I think one thing that hasn't been talked enough about -- if you look at the one common theme among the winners is they tend to have a stronger digital capability. But what I mean by that is they tend to win more in social media, have better social media engagement. Remember, during the pandemic, not only the number of people using social media exploded, average users' engagement also accelerated.

Just look at those influencers, comments or likes, they all increased well-above 50%. And meanwhile, the platform has streamlined their operations and simplified those shopping features. And those together have structurally changed consumers' shopping habits. And now even my mom shops online, right?

But they also have a structural implication on businesses. I give you an example. 20 years ago, when we book a hotel room, we look it up on a map and find out the front desk number, call them, make the reservation.

Greg Bonnell - I had to phone someone. How inconvenient was that, to have to talk to a human being to book a hotel room.

Jacky He - Exactly. And 10 years ago, you can see people start going online and find those online travel agencies. Compare the price, look at the picture and make a reservation. Today, we start seeing more and more people go straight to social media and look at those short videos and how other people experienced it.

So hotels have advantage there. They own the content of those video and pictures, and they can give clients those loyalty points. So we start seeing more customers start booking those hotels rooms with the hotels themselves directly. So they are gaining share back from those online travel agencies.

Greg Bonnell - Social media seems ripe too for fashion brands. In terms if you're talking about influencers and people taking a visual cue as to how they want to spend their money, it must be a place that fashion needs to exert itself, show itself.

Jacky He - Yeah. I'm sure you know a lot about fashion. You are a fashion guy. If you look at social media, I do think they have made fashion cycle shorter and shorter. And probably an influencer in Asia can have an overnight impact on wearing style in Canada.

Greg Bonnell - Fast fashion, right? Let's talk about that.

Jacky He - Yeah, exactly. And consumers basically just need the fresh look on a more frequent basis at a cheaper price. You talk about fast fashion. Traditional fashion would take about -- they only run about two seasons, right? And they have six months in between to prepare for their design, the product procurement, manufacturing, distribution. Fast fashion can condense that in a few weeks. And that's why recently, if you hear about Shein, that's an e-commerce player, they can do that even within one to two weeks. So consumers love that.

Greg Bonnell - How does that challenge the business? Because if fashion cycles are changing that quickly, some of the people maybe who haven't adapted as quickly are going to find themselves with coats that are too long when the coats should be short.

Jacky He - Yeah. It is having a lot of competition, certainly increasing the competition with existing retailers. And not only Shein, I talk about that. And we talk about Temu. That's another very popular name this year, not because of their size, they're pretty small. But they are both growing very aggressively. They are the most downloaded e-commerce apps.

And the reason of their success, really behind their engagement with social media. And they are trying to replicate that success back in China in North America. Each of those spend about hundreds of millions of dollars in social media, and they try to engage more with customers, understand better what they need and promote their low price advantages. But can they be a more material threat?

That would depend on whether they will retain those customers. If you look at Temu, their monthly active users has been declining month over month since the summer. That means customers after downloaded are not using their platform on a recurring basis.

If that happens, it will make them hard to scale. Remember, the advantage for them is low price because of supply chain. But disadvantage for them is the quality and services.

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