25 May 2022
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In this insight, Sentadell Associates has conducted a short research based on past crisis data (walk forward approach)to predict what the future of the equity market would be in this economic climate.
Today's economic condition has changed the way consumers treat their spending. The increase in the Inflation rate, Cost of Food and Energy, Supply Disruptions, and war risk (Russia and Ukraine) have created consumer behavioral change toward all products and services. This change, however, reflects in the equity market's performance in most sectors. Consumer Discretionary is the prime example of this event. Consumers would choose to tighten spending on discretionary products as they would shift their spending priority to more primary products. Therefore, Consumer Discretionary sector has faced an uncertain future in the short run from these behavioral shifts. This risk could be seen in Netflix. As a firm that operates in Consumer Discretionary sector, Netflix has a high risk of losing user engagement shortly. The loss of 200.000 users has proven that the shift could hurt the big players within the sector as the equity value has down -56% from February 2022 to April 2022. The solution for the discretionary sector overall would be the price reduction to obtain old customers. However, the price reduction is not a feasible solution for the current economic climate. Even if the company tried to adjust the price to almost equal to the marginal cost, the firm needs to be aware of the external cost that impacts working-class people. The external cost would be in form of the cutting jobs, a declining increase rate in payroll, and an unstable mortgage rate.
In addition to Consumer Discretionary sector risk caused by multiple factors, Investors also feared the slowed down of economic growth caused by Federal Fund Rate increase in the US. Although the Fed has increased the rate to stabilize the price, the rising interest rate would mean the economy has discouraged consumers to spend more. This has the potential to weaken the economy as the boost is needed by the economy's post-pandemic condition. The marker could be seen clearly. The supply disruptions and low purchasing power had weakened global economic growth by 3,9% in 2020. Therefore, what the economy needed the most right now from Central Bank is encouraging sustainable growth during this crisis and post-pandemic stage. Investors might be able to hedge their capital to Consumer Staples as consumer spending is directed towards the sector.
A graph from the past economic crisis (1989-1993) shows that consumers would shift towards primary food and beverages rather than discretionary products such as spending on fast food restaurants and automobiles. Indexes in the above graph are deduced from 20 companies in two different sectors and use equal weight indexing to produce the value. Food and Energy cost value are calculated by combining CPI and Brent Crude Oil prices.
Although the Consumer Staples could be viewed as stable in this state of the economy, the economy also faces unprecedented risks regarding the unemployment rate. The rationale behind this is that lower spending means the economy produces less output. Less output means less revenue for the firm within the economy. Less revenue means the firm needs to maintain efficiency in the financial market as investors demand stable EPS. As an impact, the labor market could be at risk from these circumstances as well.
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