What this quirky trend tells you about the economy (and 3 stocks to profit)

Ever bought yourself a little treat just because you were having a tough time and ‘deserved it’? Unless you have the self-control of a saint, chances are you’ve treated yourself from time to time. If you are like millions of others today, the types of small treats and luxuries are a strong indication of the economy and how you feel about it.

I’m talking about the Lipstick Effect, a term coined by Professor Juliet Schor in her book The Overspent American, and a quirk typically seen in tough economic times. In fact, it has been observed in the Great Depression and recent downturns from the 1980s onwards.

But are we seeing it now and if so, what does that mean for the stocks set to benefit?

In this wire, I’ll take a closer look with the help of ANZ economist Madeline Dunk and a panel of stock experts: Ben Clark from TMS Capital, Henry Jennings from Marcus Today and Michael Wayne from Medallion Financial Group.

Putting lipstick on the pig: what is the Lipstick Effect?

At the most basic level, the Lipstick Effect refers to the idea that in tough economic times, people will treat themselves to smaller luxuries – like a lipstick – when they can’t afford big-ticket items.

It’s not an idea exclusive to lovers of make-up though. It’s the idea of any form of little luxury, a transfer.

“People look for ways to indulge that aren’t as expensive as choices they may have made a few years ago,” says Dunk.

For example, if you can’t afford a nice dinner out, you might instead treat yourself to a nicer cut of steak at the supermarket. You might buy more chocolate. It’s the next thing you might be able to afford in a tighter budget that will still give you a treat. Can’t afford a trip to the movies? Suddenly, that monthly Netflix fee is looking a bit more reasonable.

While this sounds like standard budgeting behaviour, it’s significantly more pronounced in tough economic times, a clearer and more obvious trend.

It’s a hard-knock life

Looking around, it seems reasonable to assume the Lipstick Effect should be in full sway. Inflation has hit the average grocery basket hard, there’s a rental crisis, and property prices across Australia are high.

As Dunk points out, “there’s no doubt the economy is slowing. Activity has taken a hit, and household budgets are being squeezed by inflation, rate hikes and taxes – though the stage 3 tax cuts will alleviate some pressure.”

Is it reflected in the data?

“If you look at retail sales over the last year, pharmaceuticals and cosmetics have grown around four times faster than other retail. The challenge is it can be difficult to pinpoint the exact reason. Anecdotal evidence suggests there may be a Lipstick Effect,” says Dunk.

She notes that, based on May data, pharmaceutical and cosmetic-related retail spending is up 42% versus December 2019, compared to a 29% in all other retail.

You could argue that the Lipstick Effect has been a significant factor behind Wesfarmer’s Kmart's success in the last year, with Kmart's profits soaring 26.5% in the second half of 2023.

Woolworth’s quarterly report for March 2024 referenced strong performance in Beauty, Celebrations, and Events, though lower sales in every other segment.

If we follow our US compatriots, there’s more firm evidence of the Lipstick Effect.

Sephora, for example, had record sales last year and posted double-digit growth in the six months to 30 June 2024. Orveon, which includes brands such as Laura Mercier and bareMinerals, has seen digital sales jump from 16% in 2022 to a projected 23% in 2024.

The Australian Bureau of Statistics data also paints an interesting picture, with the latest data as at end May 2024.

Food retailing, household goods retailing, clothing, footwear, personal accessory retailing, and other retailing were up compared to the previous month.

Within food retailing, liquor retailing rose the most by 6.1% – you could extrapolate to say that if people can’t afford to go to pubs and bars, they might instead treat themselves at home. On the side of household goods retailing, it was furniture, floor coverings, houseware and textile goods that humped. Other retailing saw pharmaceutical, cosmetic and toiletry goods jump 1.4%, while newspaper and book retailing rose 0.8%.

On the flip side, department stores – the bastion of pricier luxury, declined, as did cafes, restaurants and takeaway food services.

Dunk cautions that we don’t have tangible evidence to clarify that these trends definitely relate to the Lipstick Effect, though “anecdotally and based on company reports, there are signs people are opting to trade down on treats.”

Spending across June and July may be a different story, given the abundance of end-of-financial-year sales and events like Amazon Prime Day. The Beforepay Cost of Living Index suggests that spending lifted 6.11% in June, with discretionary spending (clothing, footwear and cosmetics) seeing the biggest rise.

The big winners of the Lipstick effect

While tough economic times generally spell bad news for companies in the discretionary retail space, the Lipstick Effect does not make this a universal story. I asked a few of the experts to nominate their pick beneficiary.

Ben Clark, TMS Capital – Wesfarmers (ASX: WES)

To date, Wesfarmers has been an unsurprising winner in the tougher climes.

“If you look at the results in February, the big surprise was the success Target is now achieving and that is largely through the roll-out of a home brand that is being distributed into retailers outside of Target and Kmart,” Clark says.

He also points to the ongoing success of Bunnings and how it is embedded in consumer brains as being a source of best value.

It is one of Clark’s largest holdings at present.

Henry Jennings, Marcus Today – Lovisa (ASX: LOV) or Universal Stores (ASX: UNI)

Jennings isn’t convinced we’re seeing a large instance of the Lipstick Effect and Dunk too concurs it isn’t as pronounced as in the GFC. He believes spending is split – with older Australians less impacted by the challenges still spending, while those in the 28-40 bracket are trying to get on the property ladder (or bunkering down to pay mortgages).

That said, his picks to take advantage of any effect would be either Lovisa or Universal Stores.

“From a demographic perspective, the clientele for these businesses are less under pressure from rates and it is more ‘recession-proof’,” Jennings said.

 

Michael Wayne, Medallion Financial Group – JB Hi-Fi

Wayne has noticed many high-quality retailers have held up better than expected of late, however, suggests JB Hi-Fi would be a good option.

“It’s a high-quality retailer, and it’s easy for people to go in and upgrade their electronics and technology without necessarily breaking the bank,” Wayne says.

While seeing a drop in profits earlier this year, the retailer still topped expectations and its share prices jumped accordingly. It is also expected to benefit from the launches of new mobiles from the likes of Samsung and Motorola – mobiles being a new essential product with the death of landlines.

Are you participating in the Lipstick Effect? Let us know your favourite beneficiaries below.