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Oscar Pulido: American consumers often seen as a bellwether for the global economy have been largely resilient and healthy, despite sticky inflation and higher interest rates. But can this resilience continue as difficult market conditions persist. Welcome to the Bid. We break down what's happening in the markets and explore the forces changing the economy and finance. I'm Oscar Pulido.

In this episode, Lisa yang, portfolio manager and co-head of the Consumer Industry Super group within BlackRock Fundamental equities, joins me to give a pulse check on consumer resilience and the implications to the equities market. Lisa, welcome to the bid. Lisa, thank you so much for joining us on The. Bid.

Lisa Yang: Thank you so much for having me today.

Oscar Pulido: So, Lisa, we actually spend a lot of time on The Bid talking about saving and investing. But today we're going to talk about spending and consumption, and we're going to look at it through the lens of the U.S. consumer primarily. So maybe tell us a little bit about the sentiment that the U.S. consumer has right now, and is that the same in other parts of the world for consumers in other regions?

Lisa Yang: Yeah, Oscar consumption is vastly important to the U.S. economy. It makes about two thirds of GDP, and at a high level, the U.S. consumer is healthy, but there are some signs of weakening.

On the positive side, retail sales and consumer spending are still healthy, the labor market remains really strong, unemployment rates are below 4%, and wage growth is really robust at 5%. On the negative side, interest rates have remained stubbornly high, and savings rates are at decade lows.

Consumer confidence has also been declining, and that's across income groups and across age groups. Consumer confidence actually recently hit a two-year low, and it's driven by a few factors. So firstly, on the margin, people are a bit more negative about the job market. We've seen a lot of public layoffs from industries fromtech to autos, and while the rate of inflation has come down, price levels themselves are still really high. Take food as an example. Food prices are 30% above where they were in 2019. That puts a lot of pressure on U.S. households, especially lower income, U.S. households who spend more of their income on food.

We're seeing and hearing from a variety of different consumer companies, that consumers are more focused on value. We recently had a fast-food chain report and on their earnings call they mentioned the word value 60 times. That's quadruple the number of times from the prior quarter. So broadly the U.S. consumer is still spending, but they're spending more on promotions and they're down trading to cheaper options.

Now if we move outside of the U.S., there are two countries that are really important for global consumption, and that's China and India. And these two countries are seeing very divergent trends. China consumption is still sluggish, and that's driven by a weak property market and limited government stimulus.

Consumer confidence is low and that's driving people to save rather than to spend. And when they do spend, they're being more discerning, they're being more price sensitive. Now this does pose a challenge for many multinational consumer companies because they've really benefited from this decade plus of prosperous growth from China pre pandemic.

And now these companies are looking to other places for growth, and one of those places is India. India consumption has been really strong, and India is also the beneficiary of structural growth drivers. Their population is increasing India's population, eclipse China's for the first-time last year. It's also a really young country, half of the population is below the age of 30, and there's also a lot of room for per capita consumption to catch up to other countries. So, we feel that spending in India has a robust runway.

Oscar Pulido: So, India seems like, the most constructive consumer market of the three you mentioned, the U.S. perhaps a bit more mixed, it's been strong, but some signs of weakening.

You touched on inflation and consumer confidence that has been declining and then, and then China perhaps seemed like of the three, the one that has the most headwinds. But, when you look at spending patterns, whether this is in the U.S. or globally, are there differences between what generations, different generations spend their money on?

Lisa Yang: I think the different generations are much more alike in the way they spend than they are different, but there are some macro and micro level differences that are certainly notable. I do want to caveat this by saying that these are really broad generalizations. Gen Z alone is comprised of 70 million people in the U.S. so there's a lot of variance even within that cohort.

But at a high level, the younger generation has less spending power than older generations did when they were in their twenties and early thirties. That's driven by the fact that the cost-of-living inflation has far outpaced wage growth, and also by the fact that younger people have more student debt.

This is a more educated population and they've taken on more student loans. This makes big ticket items such as cars and homes, really less attainable for the younger generation than it did for the, for the older generation. It's also led to more value seeking behavior, and that's helped to fuel the growth of off-price retailers and discount platforms.

The younger generation also spends more on experiences. They tend to value experiences over physical goods. Now I think some of that goes back to the affordability issue. If you can't buy a home, if you can't buy a car, you want to spend your money on other things that bring you joy, such as traveling or going out to eat.

I think another driver of this preference for experiences is social media. Seeing friends and family take exotic vacations certainly fuels a sense of FOMO or fear of missing out.

The last macro level difference is that the younger generation is more tech savvy. Gen Z are digital natives. They're very comfortable shopping online, getting food delivered, ordering car services. And so, in that sense, it's really important for consumer companies to have digital distribution and really excel at digital marketing so that they can reach that end consumer.

So, it's really important from a consumer company's point of view to have these forms of digital distribution and to really excel at digital marketing so that they can reach that end consumer. Yeah, there are also some micro level differences. I'll name two as an example. So, the younger generation prefers their coffee cold. They like ice coffees and cold brews over hot coffees. They don't smoke cigarettes, but they vape. So, bringing it back to what we do as investors, it's really our job to contemplate all of these macro and micro level differences and determine which companies are best positioned to benefit from these themes.

Oscar Pulido: Right. And Lisa, you, you are an investor who looks at the consumer sector, which is a pretty broad ecosystem of, on the one hand essentials that you have to buy. I am just thinking about food and beverage. you need to eat, and you need to drink. And I'm just thinking of staples that you need in your life. And on the other hand, you mentioned experiences, travel and leisure, which is kind of at the other end of the, of the spectrum. So do consumers equally weight the purchases they make in these categories, or do you see them skewing in one direction or the other?

Lisa Yang: Yeah. Essentials by their very nature have been resilient in the context of very high inflation. So, for consumer staples companies, it's been a really favorable environment where growth has been bolstered by pricing, although that is now fading. Even within the essentials category, volumes are slightly negative, and that's because prices have just reached such high levels, consumers are increasingly shopping in these value channels such as discounters and club warehouses, and they're down trading to private label.

Now on the discretionary side, we really have to distinguish between goods and services. Services have been really strong, and by services I'm referring to experiences such as traveling and going to a theme park and going out to eat. There's been a structural shift away from goods to experiences, and that certainly took a pause during the pandemic, but it's rebounded back really strongly and helped to fuel the growth of the services sector.

Take travel. U.S. airlines reported air traffic up 30% in 2023. The live music industry is also booming. The top 100 global concerts saw sales increased 50% in 2023, and 24 is expected to be another stellar year. Discretionary goods, on the other hand, are still challenged. Apparel is back to normal, but consumer electronics, home goods, furniture are all still negative.

Now, remember, consumers loaded up on these products during the pandemic and we haven't yet hit the replacement cycle for some of these products. The replacement cycles can be anywhere from three years to 10 plus years. On top of that, housing-related categories are also facing some structural headwinds.

Mortgage rates are the highest they've been since the year 2000, and that's depressed housing turnover and housing affordability, and certainly negatively impacted home improvement stores and certain housing categories.

Now bringing this back to investing, we always want to balance the fundamentals with valuation. And as investors, we're increasingly looking at opportunities within that discretionary goods basket because we think the market may have gotten too pessimistic on some of these stocks.

Oscar Pulido: And even in that discretionary goods basket, it seems like there's a lot of different types of companies and, and sub industries. So as, as somebody who's a portfolio manager and a research analyst looking at these types of companies, what, what are some of the characteristics that you and your team look for in these consumer-based businesses?

Lisa Yang: Yeah, that's the beauty of the consumer sector is there's a large variety and there's really something for everyone.

So, if you're looking for income, you can buy tobacco stocks that have dividend yields as high as 10%. If you're looking for growth, you can buy a restaurant company or a luxury company. If you're looking for defense or downside protection, you can invest in staples, you can get U.S. exposure, EM exposure, global exposure.

There's really a large variety. And in a similar vein, there's a variety of different investors here at BlackRock, ones who are focused on the U.S. market, the EM market, growth teams, value teams, and everyone brings their own view to the table. And it's not uncommon for different investors on different teams to come to totally opposing views on the same stock.

And that's okay. But at a high level, we're looking to invest in businesses that traded a discount to their ability to grow and generate strong returns on capital. Ideally, we want to invest in a business that's in a growing category that's gaining market share. We like businesses with a wide moat and a unique competitive advantage, and we want to invest with good management teams that have a history of strong capital allocation, and we want to buy those businesses at a discounted valuation multiple.

Increasingly in today's environment where we are seeing some signs of weakening in the consumer, we're looking for more resilient businesses. So, some businesses have really strong competitive advantages that allow them to grow regardless of the macro environment.

Take the beauty category as an example. There is a global beauty company that's been able to grow in the China market, even though beauty category in China is currently flat. And that's because they have really strong brands. They've invested a lot behind those brands and they're gaining market share. Other businesses are countercyclical. They outperform in weaker economic times. That's because they offer a really strong value proposition, think fast food restaurants and club warehouse stores.

Lastly, we're more focused on businesses with strong balance sheets. These businesses are a lot more resilient in downturns, and they often come out the other end in a stronger position because they're able to buy weaker competitors or weaker competitors exit the market completely.

Oscar Pulido: You touched on a number of characteristics that you look for in, in these companies, and ultimately you said resilient businesses, ones that have a wide moat, a competitive advantage that are growing market share. But the consumer sector also has a lot of fast-changing trends and tastes can change pretty quickly. How do you keep up with that fast-changing environment and still try and invest for the long term?

Lisa Yang: Yeah, we've seen disruption in the consumer sector really ramp up in the last decade, and that's driven by lower barriers to entry. So, if you can remember a time before social media, the primary way in which a brand reached a consumer was through television ads.

So back in 2010, a 30-second TV spot might set a brand back a few hundreds of thousands of dollars. Today, you can buy an ad on a leading social media platform for just 50 cents to a dollar per click. Alternatively, if you're a celebrity or if you're an influencer, you can launch a brand on social media at no cost and instantly reach millions of people.

And so social media has really made it much easier to reach consumers. Distribution has also changed a lot. Back in the day, you have to go into a store to buy a product. Retailers offered at most 200,000 different products. Then e-Commerce came along and now the leading e-commerce company offers hundreds of millions of different products, and so they've really democratized distribution and made it so much easier for smaller brands to be sold.

Now while the barriers to entry have come down, the barriers to scale are still high. Take spirits. As an example, in the U.S. we've seen a lot of new smaller spirits brands be launched in the last decade, but only a handful of them have been able to scale, and that's because it still requires a lot of resources to get to a certain size.

Bigger consumer companies have increasingly taken to buying these smaller brands as a source of external R&D and using their variety of resources to help those small brands scale. On the topic of changing trends, there's certainly been a spectrum of durability of trends. I think that the best consumer companies have a really great pulse on the consumer, and they're either driving trends or they're quickly adapting to changing trends.

We tend to be more cautious on fad driven areas such as fashion apparel. Ideally, we want to be levered to longer-term structural themes. An example is the increasing popularity of Mexican food and beverage in the U.S. That's driven by an increasing his, Hispanic population and changing consumer taste.

That structural theme really gives U.S. confidence in the longer-term outlook for some of our investments in Mexican concept food and beverage companies. Stepping back, one of the most important aspects of fundamental analysis is really to determine the durability of a company's growth rate. And being hyper aware of disruption and changing trends is really important in doing that.

Oscar Pulido: It was interesting, as you were saying, back in the day before social media, I was thinking back in the day, I used to go to a shopping mall, and you haven't said that term at all in this conversation, but I, I think I know why obviously times are changing the way people consume and where they consume and where they consume their advertising. The other thing that is changing is technology. You, you touched on that a bit. We've talked a lot about artificial intelligence on the podcast and its impact across industries. So how is it impacting either the consumer itself or maybe how the companies in the consumer sector are doing business?

Lisa Yang: Unsurprisingly, digital native e-commerce companies have been very quick to deploy GenAI. We have a leading U.S. e-commerce company which recently launched something called Gift mode, and that's a different way of searching for the right product. You input a few attributes of the person you're shopping for, and they use their algorithm to surface the best gift ideas for that person.

Another leading e-commerce platform has used GenAI to summarize product reviews. Instead of scrolling through pages and pages of product reviews, you can very quickly see the key positive and negative attributes of a product. This is a win-win for the consumer and the e-commerce platform. It makes it much easier for the consumer to find what they're looking for, and it makes it much more likely that they shop with that e-commerce platform.

So, in that sense, I do think that Gen AI will further advantage e-commerce over their brick-and-mortar peers. Another area where GenAI is having a notable impact is marketing. Marketing is vitally important to consumer companies, and GenAI gets us closer to this concept of personalization at scale.

That's really tailoring each advertisement to the individual. So, say for example, we have a chocolate company, and this is purely hypothetical, but, for example, they know Oscar, that you're into health and wellness. They will advertise the fact that their chocolates are organic. They'll look at me and say, Lisa, we know you love a great deal, so we'll advertise the fact that our chocolates are competitively priced.

We're also seeing GenAI attack the more traditional parts of marketing, such as market research, idea generation, ad creation. There's a large U.S. beverage company that was an early partner of OpenAI, and last year they released an ad that they had created in collaboration with GenAI. And it's a really stunning ad. Highly encourage you to take a look at it. It's called Masterpiece and it brings to life some of the most famous works of art around the world, including an Andy Warhol painting of one of their products. So, I think that's a great illustration of combining human insights and capability with GenAI.

Consumer companies are still at the very early stages of harnessing the powers of GenAI, and it's really our job as investors to determine which companies can use these capabilities to further differentiate themselves and elevate their competitive advantage.

Oscar Pulido: And Lisa, you're a consumer yourself, so you're shopping and thinking about things to buy and how does that influence the investment decisions you make in your portfolios? Do you tend to, in invest in brands that you like and, and avoid, investing in those that you don't? Just how do you sort of wear those two hats of being both a consumer and an investor? How do those two worlds collide?

Lisa Yang: I think that's what makes consumer investing so fun and dynamic. I can't tell you the number of times I've looked up who owns X, Y, Z brand based on an interesting brand that I've seen read about or heard about.

I do think it's really important as a consumer investor to be a consumer, and it's certainly a great excuse to go shopping and try new products. But at the same time, I don't want to over-extrapolate my preferences and my biases. As an example, I'm personally not a fan of the way energy drinks taste. I'm a coffee person through and through, but that certainly hasn't stopped us from investing in energy drink companies.

Oscar Pulido: Right. Consumer preferences can, can vary widely. So, your consumer tastes are just one subset of that and you're trying to sort of understand broader consumer preferences as well.

Lisa Yang: Exactly.

Oscar Pulido: Well, Lisa, thank you for spending your time with us here on the podcast. A little bit of a pun there, I suppose, given the topic that we just discussed. And the U.S. consumer as you mentioned, is two-thirds of the economy and the U.S. economy being the largest in the world. So, what the U.S. consumer does is important to follow. Thank you for joining us on the podcast and we look forward to having you on again in the future.

Lisa Yang: Thank you so much for having me, Oscar

Oscar Pulido: Thanks for listening. If you've enjoyed this episode, check out our last episode with Carrie King, where she discusses equity opportunities beyond AI.

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This material is intended for information purposes only, and does not constitute investment advice, a recommendation or an offer or solicitation to purchase or sell any securities, funds or strategies to any person in any jurisdiction in which an offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The opinions expressed are as of the date of publication and are subject to change without notice. Reliance upon information in this material is at the sole discretion of the reader. Investing involves risks. BlackRock does and may seek to do business with companies covered in this podcast. As a result, readers should be aware that the firm may have a conflict of interest that could affect the objectivity of this podcast.​

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