Until recently, luxury name stocks have been strong performers since Covid. This was assisted by a massive resurgence of travel to top destinations for luxury goods, and the United States becoming a more important customer in the global luxury framework. For years in the global luxury world, there was one main game in town, and this was what the Chinese consumer was doing. Chinese travellers were drawn to luxury purchases during their European holidays as the cost of these items was lower than if purchased locally in China. There were even ‘luxury buying tours’ where groups of tourists went on trips with one of the focuses being to buy luxury items overseas. China was hit especially hard over Covid, with the most stringent and extended lockdowns in the world. Given this dynamic, one would have expected luxury businesses to have a tough time post Covid, but in came the US, roaring to a new high in global luxury participation. One must acknowledge the brilliant job the luxury companies did in this regard. This did not only occur domestically in the US, but on overseas vacations in Europe as record numbers of Americans took to the skies in the freedom offered in a post Covid world. Additionally, there was a lot of money in the bank. Lockdowns and no travel meant less places to spend money. So now you had effective luxury marketing campaigns, a strong desire to travel, and lots of saved money. This all came together in a wonderful luxury-demand cocktail. The US stock market was also roaring to new highs, and this has historically been an indicator of decent luxury demand as it improves consumer sentiment. On the one hand, you are making more money if you are invested in the market, but on the other hand and more importantly, you feel good and wealthier in a rising market, so why not buy that bag or that bracelet, after all, you deserve it!
This dynamic, as well as some recovery in Europe, fuelled the luxury run for some time post Covid. Higher volumes and higher prices (and in some cases significantly higher prices) all fed into expanding margins for the luxury companies, causing their earnings to increase significantly. Looking at certain luxury items, from the start of 2019, there have been price increases of 40%+. This increase in earnings growth leads to a rerating on the stocks and the combination of higher earnings and higher ratings leads to higher stock prices. Investors then looked at how the pent-up demand from the lockdowns in the US created a tsunami of buying and reasoned that the same thing would happen in China. You therefore had investors banking the US uptick, and now waiting for the wall of Chinese money to hit the luxury markets post their lockdowns. However, this did not happen.
The hit to the Chinese people from their stringent lockdowns was far more defined than other geographies. Travel was slow to come back, and in some cases is still not close to 2019 levels. On top of this hit to confidence, the depth of the property issues in China became more apparent. Whereas in the US confidence in wealth is tied more to the stock market, in China this is tied more to the property market, and the situation for the property market in China has become dire, with drops in property values being significant. The confidence of the Chinese consumer has been battered and is not coming back fast. But what about the argument that the rich are still rich and can buy luxury? There is truth to that, but we are talking about year-on-year growth. If Mr or Ms rich person bought a $30,000 item last year, and this year all they see is bad news, are they going to feel like going out and buying a $50,000 item? There is another dynamic specifically in China to consider. Chinese economic policy, or the perception at least, is putting a great focus on uplifting the masses. This has resulted in a degree of ‘luxury shaming’ where you do not want to show off your wealth. This has also led to higher demand in ‘quiet luxury’ which are luxury items that do not advertise the brand. In addition to this, there is still a fair degree of even higher-end luxury purchases carried out by aspirational consumers. These are consumers who would not be considered high net worth but may splash out here and there, and in an environment like this, those purchases would drop drastically. A good example is watches.
The online luxury company Mytheresa, which has made somewhat of a success selling luxury on their platform, indicates that they identify ‘wardrobe builders’. These are what they see as real luxury clients who are looking to build their luxury inventory. Someone who buys a sweater for a few thousand Pounds would be identified as a wardrobe builder, and the company would target them with events and special offers. They do not qualify watch buyers as wardrobe builders. From their point of view, if you buy a Rolex this year, maybe you got a nice bonus and spoiled yourself, but it does not mean you are looking for another large luxury purchase next year. An interesting fact is that watches had a significant surge during the luxury run, indicating the participation of somewhat transitory luxury interest. The outlook for luxury watch purchases has come off significantly and is currently not reflecting any significant demand.
This all talks to the question of where will the next run in luxury purchases come from, and remember, we are looking for year-on-year growth of what we have seen in the last few years. The US and European consumer seem to have run their course, and the confidence of the Chinese consumer does not seem to be coming back anytime soon. Perhaps a massive stimulus package in China will create some excitement around luxury, but this is unlikely to create actual luxury demand for some time. It looks like we are in for some muted growth in the luxury names for now, and if we cannot grow revenue faster than costs, this means margins need to come back as well.
Luxury as a sector will always be one to watch. These companies have high margins and the consumer wants to own the product. But without a clear indication of what the next driving force behind an accelerated luxury purchasing cycle will be, we may be in for muted earnings growth and a derating in current valuations.