Back to normal: golden opportunity for cyclical consumer goods July 2021

Nathalie Bally, Financial Analyst, KBC Asset Management
“Cyclical shares closely follow the ebb and flow of the economy. The Covid crisis will leave its scars, but the vaccines have caused a sharp recovery since the spring. A return to a more normal economic situation holds out the prospect of attractive growth potential for consumer cyclicals.”

What are cyclical consumer goods exactly?

• The economy grows in waves, with good years and ones that are less good. In periods of growth, demand for products and services increases. Companies raise their investments and take on new staff to meet this demand. Unemployment falls, incomes rise and we all buy more things. When growth slows down, we see the opposite pattern.

We refer to this sequence of waves as an economic cycle.

Cyclical businesses are ones that surf the waves of this economic cycle. They perform best during the economic good times, but demand for their products or services shrinks when the economy slows down.

Investing in the shares of cyclical companies offers both benefits and drawbacks. They are the first to register a profit when the economy recovers from a recession. But when times are less good, they are also the first to take a hit. Movement in the share price of companies from cyclical sectors tends to be a little stronger than that of firms in non-cyclical ones. It is important therefore to choose the right moment to invest in cyclical stocks.

You can opt as in investor to put your money into everyday items: the car you drive, for instance, the clothes you wear, the TV on which you watch your favourite series in the evening, with a glass of your favourite drink. We call these things consumer goods.

We also differentiate within the consumer goods category between non-cyclical and cyclical.

Baby food, toothpaste, bread and so on are non-cyclical: we use them every day and we don’t stop using them, even when economic times are harder. Demand for goods like this generally remains stable, regardless of whether the economy is growing or slowing down.

Car companies, by contrast, are a typical example of cyclical firms as they need a strong economy to achieve decent revenues. You don’t buy a new car when you’re out of work or are worrying about losing your job.

The cyclical consumer goods sector is highly varied.
  • Retail is the most important cyclical consumer goods sub-sector. It consists of every type of shop that supplies goods for personal use directly to the consumer: fashion, domestic goods and appliances, media, DIY, and so on.
  • Car makers and related businesses
  • Luxury goods like expensive watches, designer clothes, handbags, electronic gadgets and champagne
  • Companies that serve the leisure market: the travel sector, recreation and hospitality

Three reasons to choose cyclical consumer goods

  1. Broad recovery potential thanks to great diversity of products and services
  2. The economy is picking up
  3. Recovering job market and savings surpluses are boosting the sector
1. Broad recovery potential thanks to great diversity of products and services

The rise of e-commerce in retail is groundbreaking. Approximately 30% of total retail sales are currently transacted on line. And the volume of online sales is only expected to increase further. The Covid-19 crisis has speeded up the online trade, but there is still a long way to go. E-commerce is the shopping of the future and holds out the prospect of many more years of structural growth.

‘Experiences’ have become more important to us in recent years. We enjoy a pleasant leisure activity more than money in the bank. The pandemic and the associated lockdowns brought an abrupt end to the trend towards increasing leisure spending. Hospitality and tourism have been hard hit worldwide. As the economy reboots and we resume our normal lives, these hard-hit consumer services could make a nice recovery.

The car industry has also suffered badly during the crisis. Now that the economy is recovering, demand is also picking up. This will allow volumes to get back on track, which is very important for the car industry and its suppliers.

The luxury segment is structurally underpinned by demand from the emerging markets, especially China. These markets traditionally run ahead of an economic recovery.

2. The economy is picking up

Following one of the most severe yet probably also shortest recessions ever, we see a strong economic recovery this year in large parts of the world. The following indicators, at least, point in that direction:

Leading activity indicators like the PMIs (which gauge the confidence of purchasing managers of companies on both the service side and in manufacturing) and consumer confidence are rising.

• We are seeing exceptional support from the monetary and fiscal quarter: Central banks are keeping interest rates extremely low and ensuring additional money creation. o Governments are coming up with generous fiscal stimulus measures. Various support packages in the U.S., including generous unemployment benefits and hundreds of dollars in free cash per family member, are giving the American consumer an extra boost.

Economic growth, in other words, that will lead in turn to a fundamental recovery of earnings in the consumer discretionary sectors.

3. Recovering job market and savings surpluses are boosting the sector

The Covid crisis dealt a major blow to the US job market. Unemployment rose very rapidly to levels of no less than 13%. Jobless numbers have since declined quite a bit and we now expect them to improve further this year to a normal level. This could boost consumer confidence and the accompanying spending. Because higher employment and job security encourage people to spend.

US and European households have built up substantial savings surpluses. This makes sense: in periods of economic uncertainty, people postpone the purchase of things like a new car or luxury products. They save more, because ‘you never know what’s round the corner’. Now that a return to 'normal life' has begun thanks to vaccines, this could benefit the sector. Deferred purchases can be caught up with.

Did you know that...

… the Chinese market for luxury goods continues to grow.

Chinese consumers purchase around 35% of all worldwide luxury goods, such as expensive watches, designer clothes, handbags and champagne. They are the driving force behind growth in the sector. And while virtually the entire world continues to wrestle with the coronavirus, the Chinese economy is back to its old self.

China is traditionally a country where great importance is placed on status symbols. Designer goods and travel have become an important goal for a steadily growing middle class, which views them as a token of success. The importance of this will only increase further as Chinese prosperity steadily rises. Chinese consumers will thus continue to deliver a boost to the luxury industry.

Edited to 17.06.2021. This document is a publication of KBC asset management NV (KBC AM). The information may be changed without notice and offers no guarantee for the future. No part of this document may be reproduced without the prior express written consent of KBC AM. This information is governed by the laws of Belgium and is subject to the exclusive jurisdiction of its courts. Investing in the stock market is uncertain and involves risks