The new checklist – where to invest as inflation hits home

If the recent gloom from central banks has you dusting off your recession playbook, think again.

A downturn may be looming, but – to use a now-familiar adjective – the circumstances are very much ‘unprecedented’.

A new trio of forces is disrupting the investment landscape:

1. Severe and broad inflation – the cost of labour, transport and commodities has reached levels not seen since the 1980s. Central banks are warning that this risks pushing economies into recession later this year.
2. Falling household incomes – disposable incomes are forecast to shrink at their highest levels in over 50 years (eg by 2.2 per cent in 2022 in the UK)
3. The Covid unwind– post-pandemic behaviour is yet to normalise, creating opportunity as well as risk
   Combined these three factors have upended traditional wisdom about where to invest.

The majority of households won’t be worse off

Each economic downturn has unique characteristics. This one happens to follow a pandemic in which the majority of households managed to save money, as lockdowns put pay to socialising, days out, holidays and commuting, and governments supported people through the disruption.

Unlike in, say, 2008, this gives them a cushion against future inflation enabling the majority of households to continue spending.

This is not the story for low-income households, which have no such pandemic nest egg. In a double blow, inflation will also hit this group harder because a greater proportion of its spend goes on non-discretionary goods, such as food and fuel, which are subject to the biggest price increases.

Value categories are not necessarily the safest bet

When household spending is squeezed, it’s tempting to bet on value categories. However, previous recessions have shown us that consumer behaviour is more nuanced than expected.

Take the juice market in 2008. During the recession, sales of expensive chilled smoothies fell by 40%. So far, so expected. However, it wasn’t the value end of the market that benefited. High-income households traded down to the middle market – chilled not-from-concentrate (NFC) juice – whereas value buyers simply switched to water. If they were going to splash out, some also turned to NFC juice as a rare treat.

Leisure’s recovery will likely continue

In the face of a recession, investors typically pull out of large parts of the leisure sector due to its reliance on discretionary spend. However, as the industry was laid low by the pandemic, its growth is about to take off (as an example, following the 2008 recession, travel’s recovery took about four years).

The inverse will be true of other industries which enjoyed a Covid-bounce. Groceries, which enjoyed a bumper pandemic, for example, may see lower growth as out of home eating recovers and prior year sales were inflated by Covid.

Your new investment checklist

The above conditions call for a new checklist to assess a category or asset’s suitability for investment.

• Inflationary resilience – how easily can inflationary price increases be passed to the consumer or offset by value reengineering?
• Income effect – what is the expected impact of squeezed incomes?
• Remaining Covid rewind – how long until trading returns to pre-Covid levels?
• Underlying growth – what was the category outlook and did Covid change it?

The above criteria can be used to put different categories, and even sub-categories, through their paces:

Pets

Overall, a category that has strong underlying growth and is typically resilient in a recession with consumers seeing spend on their pets as non-discretionary. Despite the Covid fuelled additional growth of the pets market we still expect the market to be attractive for investors.

Wellness

Covid turbocharged the consumer desire for wellness (e.g. vitamins, sanitiser, air filters) but the category was already gaining traction and the customer set is likely to be somewhat insulated from the income squeeze.

Quick service restaurants (QSR)

The sector is likely to benefit from both the net inflow of consumers during a ‘flight to value’ in a recession, as well as weaker comparables due to Covid in 2021.

Travel Retail and Budget Travel

As noted before, travel was significantly disrupted by the pandemic and consumers are still willing to spend to make up for lost time on holidays they missed during the pandemic. Travel retail’s appeal to more well off consumers, and budget retail’s appeal to a broad range of consumers appear best suited to grow during the future.

Opportunities for Private Equity

PE remains in a strong position. It has ready dry powder if it needs to move quickly and an advantage over trade buyers who are grappling with inflation. As with all challenging environments, there are opportunities; it just requires a new way of thinking to identify them.

To see our comprehensive analysis of consumer categories or to discuss investment challenges please contact our team.