28 October 2016
Tourism is one of the service sub-sectors that look promising. Photo: Xinhua
Tourism is one of the service sub-sectors that look promising. Photo: Xinhua

Why you should buy consumer stocks in 2016

Return for most asset classes was poor in 2015. Only a few asset classes recorded positive returns during the year.

But those who bet on a strong dollar may have seen better returns.

This year the divergence between the consumer and service sectors on one hand and the manufacturing industry on the other will become more obvious, bringing investors opportunities other than that resulting from monetary policies.

In 2015, non-essential consumer goods stocks in the S&P 500 index rose by a double-digit rate, much higher than those in the energy sector. Data shows the five top performers in the technology and consumer service sectors increased 62.5 percent on average.

The divergence between industries spells opportunities for investors.

In the new year, industrials and other capital expenditure-related industries will continue to be affected by worldwide oversupply, high debt levels, and the slowdown of economic growth in emerging markets.

A strong dollar and a sluggish Chinese economy have put strong downward pressure on global trade.

Since 2001 when China joined the World Trade Organization, the country’s industrialization process has been on the decline, creating troubles for global manufacturing industries.

The leading purchasing managers’ index (PMI) for manufacturing reveals a lack of growth momentum. In December 2015, developed countries saw their manufacturing PMI above 50, which indicates growth, but still lower than the high point recorded in 2014.

Bigger troubles were seen in emerging markets, particularly BRICS, where the manufacturing PMI was below 50 and is expected to fall further.

On the other hand, service PMI was outstanding. It was above 50 in most developed countries as well as in China and India, which rely heavily on their domestic markets.

While the manufacturing sector is slowing down, the service sector is growing and supporting economic growth.

Domestic consumption is significant. In the United States, an increase in wages, higher savings ratio and the completion of deleveraging will boost consumption.

In addition, low energy prices will increase consumers’ disposable income.

In the euro zone, the unemployment rate has dropped to 10.5 percent. A strong credit expansion will also lead to increased consumption.

In Japan, higher salaries and a rebound in inflation can boost domestic demand.

The consumer industry has many sub-sectors. In the service sub-sector, for example, financial services, healthcare, tourism and education are noteworthy. Local consumption sub-sectors such as online shopping, food and medicine are also promising.

However, valuations in the sector are not cheap. The price-to-equity (PE) ratio of non-essential consumer products stocks in S&P 500 index will be about 18.1 times in the next 12 months, higher than the average level of 16.1 times.

The PE of similar stocks in Europe is 25.7 times, representing a 55 percent premium to the long-term average level.

Investors should wait for appropriate prices during market corrections, instead of chasing the market.

This article appeared in the Hong Kong Economic Journal on Jan. 11.

Translation by Myssie You

[Chinese version 中文版]

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Analyst at Noble Apex Advisors Ltd

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