Spend and save

The pandemic led to huge shifts in consumer spending, which subsequently reversed. Following the pandemic boom in spending on both goods and services, US consumer spend has been normalising in 2024, returning to pre-COVID trend levels across a range of sub-sectors.

This has been sharpest in the US because that is where the spending spree had been most meaningful after the initial shock of the pandemic. It is quite different in the euro zone and the UK, where spending has been relatively flat for the last two years and has remained severely below its pre-COVID trend.

Much of the difference here can be attributed to savings levels; while the savings ratio in the US has been steadily growing since 2022 as consumers have moderated their spending, it remains slightly below its pre-pandemic trend level. In contrast, saving rates in Europe and the UK have gone far above trend levels and have continued rising.¹

There are other reasons for this variance, such as differences in the mortgage rate system, natural gas price rises following Russia’s invasion of Ukraine which were much higher in Europe than in the US, and of course the size of the fiscal stimulus in the US during COVID-19. This dynamic has favoured companies that sell to US consumers, though some of this has unwound in recent quarters as US consumers have moderated their spend.

Experience the world

A longer-term but related trend is that people have been, over time, spending more on experiences than goods. As a share of personal consumption expenditures (PCE), the US has been seeing a structural decline of spend on goods and an increase in experiences. More recently, the spend on goods has been normalising, while, for example, the travel sector has held up well.²

This informed a couple of the ideas we had in our consumer-sector hub in 2024: hotel groups Hilton in the US and Whitbread in the UK. Both ideas stemmed from the theme of increased consumer spending on experiences and our view that these names have strong fundamentals – captured in the common research template we use across our equity platform to bolster the efficiency of idea generation across all sectors.

Hilton and Marriott are the two leading hotel players in the US. Both have similar, asset-light franchising business models, which we like, and world-leading loyalty programmes, which make customers “stickier”, increasing their model’s resilience.

Fundamentally, we prefer Hilton over Marriott due to Hilton’s superior net unit growth profile which is allowing Hilton to add more new hotels to its portfolio. In our view, that will support Hilton’s higher growth potential and will result in strong compounding earnings growth over the coming years.

The group has also been growing its loyalty programme at a stronger clip than Marriott for the last few years. We see this loyalty programme as essential in creating network effects across Hilton’s ecosystem and ultimately driving the sustainability and resilience of its revenue growth. As a result, we invested in Hilton in our Global Core equity strategy in 2024, combining our fundamental views on the name with our insights on the thematic of spend on experiences.

This is just an illustration and there are always risks, but this example shows how we use our knowledge of trends and sector expertise to uncover investment ideas within our sector hubs.

A second key trend is that recent events in the US and UK may have inflationary effects, with important implications for consumer firms.

In the US, Donald Trump has talked about potential tax cuts for individuals, which may give consumers more discretionary spending power, but also high tariffs.  

Taking a step back, consumers are coming out of several years of high price-inflation, during which companies had to pass on their increased costs. And central banks have only just brought inflation back down towards their targets. The possible onset of high tariffs could again result in higher costs for companies, and therefore higher prices for American consumers. This was the perspective of the US companies we recently engaged with on the subject.

From a sector perspective, that is a concern because consumers have begun pushing back on price rises. In recent earnings reports, companies have mentioned customers wanting more value: consumers are feeling the impact of inflation and are now adjusting their spending habits. It can take 12 to 18 months of inflation before people start to see it consistently in their wallets and change their spending accordingly.

In terms of the recent market response, companies focused on lower-income consumers have underperformed because of this. Lower-income consumers have been suffering for a long time and were just starting to see some relief on the horizon, but could now see inflation going back up. Conversely, companies that play towards higher-income consumers have generally been outperforming because the US Republican agenda seems supportive of pro-growth, pro-cyclical parts of the market.

But this agenda might also lead to a stronger US dollar. That has implications for all companies with revenue or cost exposure to the dollar and could particularly hamper some US staples names with high emerging-market exposure.

Inflation in the UK

For different reasons, there is a similar backdrop in the UK. The Bank of England has recently started reducing interest rates given inflation is more under control, but the November 2024 budget announcement could have inflationary effects.

At a recent consumer-sector hub meeting, we discussed the increase in employer National Insurance Contributions. That will have an obvious impact on labour-intensive companies, such as the big supermarket chains. For example, Tesco, which is one of the companies we engage with, could see an increase to its cost base of around £1 billion over the next four years from this rise alone, and will have to decide what proportion it would pass on to consumers.

Going into 2025, this environment could be a challenge for consumer companies. It will be interesting to see how businesses navigate decisions around passing cost through to consumers and acknowledging consumers have become more sensitive to prices due to their recent experience of persistently high inflation.

Pump up the volume

In this context, we are looking for companies that can drive sustainable volume growth. Over the last couple of years, strong prices were a tailwind for many consumer companies (and other sectors). Now this is abating, the companies that can drive strong top-line growth will be those that can consistently propel volume growth.

And because commodity-cost inflation is now much more benign than over the last few years, we think companies that can push volume growth are also well positioned to improve their margins – and profit growth.

This will be even more relevant if the incoming Trump administration raises tariffs because, as discussed, companies may not be able to pass on all price rises. That means volume will become more important for companies to grow their top line and margins, and not feel too much pain from higher costs.

As an example, a sub-sector we like for volume growth over the longer term is the beauty industry. One key reason is that more emerging markets are seeing stronger GDP-per-capita growth, which generally correlates with increased spending on beauty and wellness products. For instance, over the last few years, India has seen an increase in spending per capita on beauty as its GDP per capita has risen (though it is still at comparatively low levels with much potential runway ahead).^3,4

There are always risks, but we like that structural tailwind in terms of emerging economies’ potential to engage with the beauty industry. As an example, we have exposure to French beauty company L’Oréal across a number of our strategies. At its first-half results, L’Oréal said its emerging-market business was now the same size as its Mainland China business, demonstrating the inroads it is making in some of these markets.⁵

In contrast, the spirits sub-sector could be facing structural headwinds. For example, younger cohorts’ consumption of alcohol and spirits has been under pressure for the last few years, particularly in the US. In 2022 and 2023, American 16- to 24-year-olds’ total alcohol and spirits consumption dropped below its 2019 levels.⁶

For several years, spirits companies’ revenue growth has primarily been driven by price and mix (mix means growing by shifting the product portfolio towards higher-margin parts of the business). Therefore, while some of the drop in demand may be cyclical, we see less potential scope for volume growth in this area than in other consumer sub-sectors. We expect these companies will have to drive more pricing-led growth to meet their profitability goals, which we don’t find as attractive.

Over the longer term, China is the big challenge in the consumer sector, more so because many of the companies we look at are large multinationals with exposure to this huge market. They have all seen weakness in consumer demand, which has worsened through 2024, mainly because of poor consumer sentiment.

The savings rate in China is far higher than in the likes of the US and Europe, so we think unlocking consumer confidence will be key to consumers reengaging with spend on goods.⁷ Concerns around job prospects, high unemployment, and the property-market crisis have all contributed to keeping consumers out of a spending mood.⁸

The challenge is assessing whether this is a cyclical trough or a structural issue. The Chinese market has historically been very dynamic, which is why consumer companies expanded into China, and why most have so far chosen to remain.

On November 8, 2024, the National People’s Congress (NPC) announcement of further economic stimulus was rather underwhelming from a consumer standpoint. There had been some hopes of direct support through handouts, as the US did during COVID-19 and which had led to a big pick-up in spending, but those hopes were disappointed.⁹

There could be more to come, but we think the government is focusing on stabilising Chinese financial markets for now. Although large handouts would be very supportive for consumer companies, we are not expecting any in the near term. From a stock-picking angle, that makes it challenging to have visibility around when consumer demand might improve. This sentiment has been echoed by the companies we speak to that have footprints in China.

Demand weakness is impacting both discretionary and staples. On the discretionary side, luxury companies are the most affected because their revenue exposure to China is typically 20 to 30 per cent of sales. But some staples companies have large exposures as well, if not quite as large as in luxury. We remain aware of the risks around China and are selective in investing in fundamentally strong businesses with geographic diversification that can weather further volatility in Chinese consumer demand.

The art of (trade) war

On the other hand, we have been observing a trend around Chinese trade wars – that of Chinese electric vehicle (EV) manufacturers expanding into Europe with aggressive pricing on lower-cost models. While it is negatively impacting European auto companies (to which we have no exposure in our equity portfolios), it is benefiting the Chinese players. This has given us an investment preference, again, from both a trend and a fundamental perspective, and one we have held for some time.

As an illustration, BYD, the largest Chinese player, is one of our favoured ideas, fundamentally, but also because we think it is likely to continue expanding its market share. Its ability to produce at very low cost is particularly relevant with consumers emerging from several years of high inflation and interest rates. We hold this company across several of our global and emerging-market strategies.

And while some European consumers may have been less trusting of Chinese brands in the past, these companies have built trust through their efficiency, scale, model ranges, and an aggressive marketing push in Europe.

Of course, there are risks, and this is an illustration and not an investment recommendation. For instance, Europe has responded by voting for tariffs on those Chinese players, which is a risk to be aware of. But Chinese players’ production costs are so low, their cars remain cheaper than European incumbents’ even with tariffs. Therefore, we don’t see it as a meaningful issue that could stop them from continuing to build market share in Europe.

Going back to an earlier theme, there has also been a retaliatory response from China, which is imposing anti-dumping policies on European spirits players. That is another reason why we are more cautious in that space.

Living in interesting times

Many of the themes are intermingled, and the increasing signs of the China-Europe trade war are interspersed across a number of our ideas. In the coming weeks and months, we will be keeping a close eye on these signs, inflationary trends, consumer sentiment and developments in the US, among others.

No doubt our consumer hub discussions will be lively, generating new ideas and challenging older ones in equity portfolios. In the current context of change and uncertainty, 2025 will be an interesting year for investors, with many risks, but also opportunities to be uncovered.