Weak consumer spending globally, volatile emerging markets (EM) currencies and an expanding inflationary environment in emerging markets have weighed down on many consumer product companies in 2013. The 22% rise in the global Dow Jones Consumer Goods (DJCG) index last year, lower than the 32% increase seen in the S&P 500 index, succinctly represents the performance of the consumer goods sector across the globe. Individually, large cap companies such as L’Oréal (OTC:LRLCY), Unilever (NYSE:UL) and Procter & Gamble (NYSE:PG) have under-performed the broader S&P 500 index during the year, with gains of 27%, 21% and 8% respectively.
So far in 2014, the global DJCG index continues to marginally lag behind the broader S&P 500 index. Cosmetics leader L’Oreal marginally lags the global DJCG index with a 6% decline compared to a 5% decline in the index, while broader consumer companies Unilever and Procter & Gamble marginally outperformed the index.
Emerging markets contribute to more than 40% of revenues for each of these three companies, and with rising consumer demand and an exploding middle-class, these markets are a substantial mover for these stocks. In this article, we take a look at major trends that continue to impact the Consumer Goods space in 2014 from an EM perspective.
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Currencies in various EM were weak during the first half of 2013, with prospective fears of a slowdown in the Federal Reserve’s bond buying program that has been supporting growth of the U.S. economy since its crash in 2008-09. These fears intensified during the second half of the year, as economic data coming out of the U.S began to accumulate to support a Fed tapering of its support. Currencies across the EM region began tumbling to all-time highs against the dollar during the latter half of 2013, fueled by a sudden spike in speculative concerns of a Fed taper by the end of the year. Economies with significant Current Account Deficit (CAD) were hit the hardest due to concerns regarding their financial position once the Fed’s taper program begins. By the time the Fed officially announced its first $10 billion reduction, most EM currencies had fully factored in the taper concerns, stabilizing at levels lower than their 2013 beginning levels as shown in the infographic below.
In 2014, new concerns regarding China’s growth have fueled a fresh depreciation in EM currencies. The Chinese PMI data, which is an indicator of the country’s activity in the manufacturing industry, was below 50 for the month of January. A PMI value lower than 50 indicates a contraction in the sector, while a value greater than 50 indicates an expansion in the sector. This value of 49.6 compared to a consensus of 50.3 for January, set off a fresh slide in global currencies, albeit a minor one, factoring for a weaker demand forecast from the Chinese market.  However, prudent rate hikes from various central banks across the developed and developing markets, to protect their currencies and create domestic liquidity, coupled with a steady fall in inflation in these markets, allay fears of any deep fluctuations for EM currencies.
Fundamental concerns such as high CAD, weak infrastructure, manufacturing, and capital goods spending, and corruption should begin to subside this year as governments begin tackling these issues to boost foreign capital inflow into their economies. For 2014, we believe any quantitative change in country metrics such as headline inflation or GDP growth should induce a change in the currency market, either on the upside or the downside, depending on the change. However, we do not expect extreme volatility in these currencies and believe that the current exchange rates are the new threshold for these currencies. This should reduce the gap between reported revenues and constant currency revenues for consumer goods companies due to lower currency fluctuations. On the flipside, a faster recovery in developed markets (DM) could lead to a flight in capital from emerging markets, resulting in further strengthening of DM currencies, particularly the U.S. dollar and the Euro, and a widening the gap between reported and constant currency revenues.
Inflationary Concerns Could Put Consumer Spending On The Back Foot
Apart from tackling sliding currencies, emerging markets also need to tackle inflationary concerns to boost consumer spending levels in their economies. Central Bank governors have their hands tied tackling inflation and currency depreciation, as controlling one means letting the other loose. Most Central Banks strategically curb inflation by hiking their lending rate to banks, called the repo rate, to decrease the liquidity in the market and lower inflation. However, given the fundamental concerns in most emerging economies and the prospects of slowing growth in heavyweights such as China and India, the continuous expansion of the repo rate could disastrously affect growth by cutting out investments. A World Bank statistic shown below indicates the widening gap in inflation between South Asian countries such as India and Indonesia and the rest of the world post the economic crash in 2008-09.
(Source: The World Bank)
For 2014, we expect this balancing act among emerging nations to continue, with stubbornly high inflation during the first half of the year. Key drivers include populist reform measures in emerging markets with an election cycle in Egypt, India, Indonesia, Thailand and South Africa. These populist reform measures could prove to be a set back to growth and result in higher inflation, leading to lower consumer spending in these regions. For the second half of the year, we expect a mild softening in inflation, driven by various policy changes and capital infusion measures boost GDP growth in the region from possible new governments.
Overall, we are positive on growth from emerging economies for consumer goods companies in 2014. With product demand from developed economies ready to bounce back, strategic product launches in EM regions could accentuate top line prospects for global players such as L’Oréal, Unilever and P&G.Notes:
- China’s factory activity shrinks, first time in 6 months, CNBC, January 2014 [↩]