Slowing consumption growth may indicate pressure in the labor market

    We have observed a pronounced and increasingly broad-based slowdown of consumption growth in recent months, including that of staples consumption. Such a phenomenon implies that employment and household income growth may be under pressure. Discretionary consumption growth took a big step down in 2H 2018. The most noteworthy drag to discretionary consumption was auto – both the price and volume of passenger car sales declined YoY in China for the first time ever in 2018; meanwhile, China’s smartphone market has been shrinking since around mid-2017, echoing Apple’s downward revision of revenue guidance earlier this month. More alarmingly, however, staples consumption growth also started to stall, particularly those consumer staples which cater to “consumption upgrading”, e.g., bottled water, meat products and fruit drinks. To the extent that discretionary consumption growth is more closely related to corporate profitability growth, the pressure on staples consumption growth clearly indicates changes in the employment situation and household income growth.

    In our view, the recent deceleration of consumption growth results from the combined impact of multiple factors, some of which may gradually dissipate. However, the pressure of employment and household income growth may rise. Looking forward, changes in employment and household income growth may become the driving force of consumption, for discretionary and staples products alike. Granted, consumption deceleration in recent months was driven by a number of overlapping factors, including (i) a deteriorating labor market (i.e., heightened pressure on real unemployment rates and household income growth), (ii) the tightening of non-mortgage consumer loans, and (iii) the negative wealth effect from the sizeable correction of financial market valuation. Looking forward, some of these factors (e.g., consumer loan tightening) may dissipate. However, as we have analyzed in a recent note, we believe that the pressure of employment and household income will likely continue to unfold on many fronts this year, considering that corporate profitability is weakening, the property cycle is softening, external demand remains uncertain, and “modern” services industries are switching to slower growth. In light of a deteriorating labor market, further downside risk looms for consumption growth, including staples geared towards “consumption upgrading”, big-ticket items, services, and housing-related consumption. Even worse, rising deflationary expectations will further deter consumption growth, as deflationary impulse reduces the “opportunity cost” of delaying consumption, especially for items with more volatile and cyclical price movements.

    Looking forward, investors and policy makers should closely monitor changes in corporate profitability growth, as well as the number of loss-making firms and the loss amount. These indicators may reflect labor market trends and changes in household income growth, and thus may be a useful gauge for consumption “turning point” this year. As we’ve analyzed, while there is no good-quality, high-frequency data that can be used to effectively evaluate short-term labor market conditions, changes in household income growth are closely tied to economic cycles through its impact on consumption and aggregate demand. Corporate profitability (and on the flip side, the number of loss-making firms and the loss amount) sheds light on the pace of household income growth, and therefore could be a useful gauge for consumption “turning point” this year. Importantly, industrial enterprise profit growth already turned negative in November 2018 for the first time since December 2015, indicating that the “negative feedback loop” between slowing consumption, deteriorating corporate profitability, and decelerating household income growth is potentially forming. Looking forward, it is not inconceivable that corporate profit growth may record a YoY contraction rate in the mid-teens this year. While the recent plan by the NDRC to stimulate consumption demand is a welcome move, the room for boosting consumption through fiscal expenditure growth may be limited – our analysis already showed that fiscal (deficit) expansion this year will largely be driven by the “automatic stabilizer” effect from the naturally slower government income growth, and that the broad-based fiscal “funding gap” would amount to more than Rmb2.5 trillion in order to just maintain the current pace of fiscal expenditure growth.