Jamie [00:00:00] Over the past decade, we've all become accustomed to the popular FAANG stocks... Facebook, Apple, Amazon, Netflix and Google. But as Tony Greer of TG Macro and Merrill Lynch have recently pointed out, their time at the top might be coming to an end, because right now there's talk of a generational shift in asset prices happening around the world. Enter FAANG 2.0 - fuels aerospace, agriculture, nuclear and gold. Now what does this mean for consumer behaviour and what does it mean for investor portfolios? That's this week's Big Conversation.
Jamie [00:00:47] Before we tackle that particular question, head-on, let's recap exactly how we got here. Whenever we evaluate a potential paradigm shift, it's easy to fall into the trap of searching for that one root cause, because when we go back and study major events throughout history, it's almost always a confluence of factors. In today's case, it arguably starts in 2014, when the US oil and gas industry experienced a historic bust. After years of overinvestment and frankly, a lack of discipline, the collapse in energy prices sparked an exodus of investor capital. Then, in the years that followed, ESG initiatives created a renewed focus on the environmental impact of the energy sector, and that led many firms to divest their holdings of fossil fuels. Then came the China U.S. trade war. On the surface, this appeared to be about fair terms of trade, but what it revealed were the potential fault lines in global supply chains. As negotiations dragged on and tariffs pushed prices higher, trade became more strained, and corporations began exploring alternative sources of supply. And then COVID 19 struck. That began labour shortages that created logistical bottlenecks. Consumers rushed to stockpile everyday essentials, all the while government stimulus payments created a surge in demand for discretionary items. Oil producers then slashed output. Mines closed due to health concerns and supply constraints led to a dramatic decline in big-ticket items like automobiles. In essence, it was the perfect storm where a major supply shock ran head-on with surging demand. Fast forward to late last year and the world finally appeared to be emerging from the global pandemic. The only problem was the reopening of the economies, marked by a rapid decline in unemployment rates, meant that persistently strong consumer demand placed continued stress on supply chains that still hadn't caught up from early 2020. So this narrative is a perfect case in point. There wasn't just one underlying event like the 2014 oil collapse. The pressures responsible for today's commodity surge and sector rotation have been building for years. Now, admittedly, the pandemic, which was hardly predictable, accelerated things, but the writing was on the wall to a certain extent. Now, speaking of predictable factors, I want to revisit something I mentioned just a moment ago, ESG. Because our transition towards greener energy has introduced another dynamic, this time on the demand side. Let's not forget ESG initiatives like electric vehicles or solar energy require an enormous amount of raw materials. Think along the lines of copper and electric vehicle (EV) is estimated to use more than double the copper of an internal automobile combustion engine. Or nickel and lithium, which are integral components of an EV battery. Now that's before you include the rising number of electric vehicles on our roadways increasing further demand for electricity. According to the International Energy Agency, or IEA, for short, nearly 70 per cent of OECD electricity production came from non-renewable sources. That's coal, natural gas, nuclear and what they call other. So while there are, of course, tremendous long term environmental benefits of a greener economy, the reality is it increases demand for raw materials that could exacerbate current inflationary pressures. We've seen similar forces at play in the agricultural commodity space. The price of foods such as wheat, corn and soybean have skyrocketed over the past year and not just for the costs associated with heavy farm machinery, but also fertilisers. As the cost of energy rises, so does the cost of producing fertilisers. In turn, farmers pay higher prices to protect their crops, and this can all ultimately lead to higher food prices. Now, this is just a quick overview of the complicated history contributing to today's commodity surge. But as Tony and Merrill Lynch point out, it can have a lasting impact. If we're looking at a structural shift driven by inflationary pressures, whether that's due to an underinvestment, the reworking of supply chains or increased demand for the transition to greener energy, investors may want to rethink their portfolio allocations because this could just be the start. Elevated levels of inflation naturally leads to higher interest rates, and higher interest rates typically have a negative impact on valuations in growth sectors like technology. The technology space typically recognises earnings further out into the future, so when discounted at a higher rate, it reduces the present value of their earnings. On the flip side, the new FAANG investments, those more aligned with near-term cash flows, which means they aren't as susceptible to multi-years of discounting. And they also benefit from rising prices or inflation. So this rotation is being both pushed and pulled and that's the reason it's happening so fast. So what are some of the attractive options then? The Metals and Mining ETF (XME) can provide diversified exposure to companies involved with steel, coal and consumable fuels aluminium, copper, gold and silver. There's also the Invesco DB Agriculture Fund (DBA), which, as its name implies, is focused on agricultural commodities. And then there's the Global X Uranium ETF (URA).
Jamie [00:06:28] Aside from this new FAANG, old FAANG debate, we also need to be aware of the impact on consumers, and this is the topic of our chatter section today. Let's take a look at real disposable income. This is defined as money available to invest, save or spend on necessities and non-essential items after deducting income taxes. Now we know that wages have been rising, but when we adjust those wages for inflation to get a sense of how far these higher wages can go with higher consumer prices, we can see the picture is a tad more concerning. Perhaps it's no surprise, then, that we're seeing various consumer sentiment surveys demonstrate an alarming level of pessimism. Does this imply the consumer isn't as strong as headline growth figures suggest? Does it mean that companies will have a tougher time passing on further price hikes to their end consumers? Or worse yet, might it suggest that the economy is at greater risk of a recession than we previously thought? It also begs the question aside from technology, are there other areas of the market out there we should be avoiding given a potential shift towards higher inflation and higher interest rates? There's retail or consumer discretionary, even homebuilders, where mortgage rates may become more expensive. To discuss this in greater detail, I sat down with Refinitiv's Jharonne Martis.
Jamie [00:00:04] Jharonne, welcome to The Big Conversation, thanks for joining us.
Jharonne [00:00:07] Good morning Jamie, it's good to be here.
Jamie [00:00:09] So we've just been talking about inflated commodity prices, and what we want to talk about now is how that's going to impact or has been impacting consumer behaviour. So if you don't mind me asking to begin with just to take a look back at the US consumer and what sentiment has been like over the past six months? Because I know on Friday I think the University of Michigan survey printed it's its lowest number in over 10 years. So just want to get your thoughts first.
Jharonne [00:00:36] So at Refinitiv, we've been covering the consumer sentiment for over a decade now, and it's very interesting because when you look at the data over the past two years, it's been the most volatile ever. We've seen ups and downs directly correlated with the number of cases of COVID. This means that the latest reading on consumer confidence has actually seen an improvement. And this is because the Americans are starting to see the light out of the tunnel, they're starting to see that the Omicron cases are starting to come down. And this is a very positive indicator, especially when you take into consider, into consideration all of the negative macro-economic factors that the consumer is dealing with right now.
Jamie [00:01:27] So are you saying that when we look at consumer sentiment surveys, we need to sort of take them with a bit of a pinch of salt because as people see the end of the pandemic coming closer, it's maybe sort of giving us in a false optimism, so to speak?
Jharonne [00:01:41] Well, you have to look at the whole picture. The biggest, the indicator, the economic indicator that has the biggest correlation with consumer spending is the unemployment number. If consumers feel that they're going to lose their jobs, they're going to put their hands in their pocket and hold back on spending. The good news is that the United States right now is seeing the best job market in its history. So this is telling us that because of this, the consumer still engage and they're still spending. When we look at the Refinitiv earnings growth rate for the fourth quarter, we see that that retail has had a very jolly holiday Christmas season. Consumers went out there and they spent and they bought gifts for everybody that they know. However, going into the first quarter of 2022, they are feeling the pinch of inflation and that consumer spending number, estimated earnings growth rate, is expected to go down to a negative 1.4 percent. This is telling us that consumer spending has already slowed down into the first quarter as consumers are dealing with inflation, and this slowdown in spending, it's already being seen at mall stores, department stores, apparel and even specialty retail.
Jamie [00:02:48] Now is that in line with what the corporates are telling us? I know most of the, the big retail guys have reported already, when they give outlooks for 2022 are they showing the similar signs of caution?
Jharonne [00:03:00] Absolutely. So retailers are reporting fourth-quarter earnings and are warning us not to expect too much from them into the first quarter. To date, we've had over one hundred and seventy companies report fourth-quarter earnings, and over 90 percent of them have mentioned the supply chain issues, and the bulk of them haven't mentioned inflation as well. They're telling us that these factors are still looming and they're affecting earnings. And when we look at consumer spending in general, it's very evident that the consumer is feeling the pinch, we're starting to see them trade down. They are going to the discounters like Wal-Mart and Target to purchase discretionary items. A big portion of the revenue of Walmart and Target used to be groceries, but this time around we're seeing that a lot of strength is coming into apparel, buying swimwear and even travel luggage, so consumers are trading down and they're gravitating to these discounters for the cheaper prices. On top of that, they're also going to the discount club membership discounters, and this is companies like Costco, Sam's Club, we're seeing the memberships, their rates going much higher because consumers are feeling the pinch at the gas pump and they are gravitating towards these rewards and the values that they're getting for a lower price for lower gas prices, even at Kroger, the supermarket, we're starting to see consumers go there because of the rewards that they're getting at the gas pump. So as a result, the Refinitiv StarMine model is telling us that investors can expect positive surprises in the first quarter for companies like Wal-Mart, B.J. Wholesales and even Kroger. These, these companies are likely to not only beat earnings estimates, but post a positive surprise.
Jamie [00:04:39] That's very interesting, thanks for that. And if you dig down into how they're spending their money, you've just alluded to the fact they're looking at these discount retailers to try and save a few pennies there. But in terms of allowing for higher energy prices and where they're spending their income is there, have there been any changes there?
Jharonne [00:04:56] Absolutely. So we're already seeing that the first post-COVID inflation hit the consumer and they funded their spending with their personal savings rate, which has come down from 8.2 percent to 6.4 percent. This is the lowest level we've seen since December of 2013. Now consumers are being hit with even higher prices because of supply chain disruptions and higher raw materials. So as a result, we're seeing that the discretionary spending has already started to change. They are trading down. But if this continues to affect the consumer into the second half of the year, that's why we are very likely to start seeing them cut back on a lot of this discretionary spending in terms of like not going to eat out anymore, not going to entertainment, going to movies and concerts and even travel.
Jamie [00:05:46] It's very interesting what you're alluding to. And I want to ask you about the future for consumer behaviour, because the consumers have found so far a few levers to pull; their savings rates gone down, they're visiting more discounted stores, but if these elevated energy and commodity prices can continue to remain, they'll feel the pinch even further. So what other levers do they have to pull and when does that really start to translate into the real economy?
Jharonne [00:06:12] So the Refinitiv data shows that the inflation will low for the first half of the year, and we might start seeing improvement in spending into the second half of the year. The two things that are, the two positive macroeconomic indicators that are helping the consumer and that continue to fuel spending, are driving spending is the fact that the job market continues to do very well. And also the fact that the cases in COVID are coming down. Now as long as these two economic indicators stay constant, we're going to still see the consumer engaged, not as before and not as strong as we saw last year, spending has already started to come down, but at least it won't hit GDP as hard. The problems will start to arise if we start seeing the employment market start to hinder. If that happens, consumers will put their hands in their pocket and hold back on spending.
Jamie [00:06:57] Well, Jharonne that's great, keep your eyes employment data, keep your eye, keep your eyes on new COVID cases, and that will be a good way to see how consumer behaviour is going to change. Jharonne it's been a pleasure having you on the show, thank you very much indeed for joining us.
Jharonne [00:07:10] Thank you so much for having me.
