Luxury stocks may be a risky China stimulus bet

October 19

Chinese consumers have long powered luxury brands to new highs. But with questions surrounding China’s sluggish economy and changing consumer tastes, analysts aren’t so sure whether these shoppers will be able to coax the luxury sector out of its doldrums. The Chinese government’s new stimulus measures announced late September revived interest in the country’s economic prospects — stoking hopes it would revive luxury spending among this critical cohort. But these measures may not target the consumers the industry most relies on, analysts say. Even if it does, the taste for luxe labels may have vanished as consumers look more closely at brands closer to home. “I personally don’t think that the Chinese have the same level of aspirational consumption like they did,” said Ben Harburg, portfolio manager at Core Values Alpha. “The wool has fallen off people’s eyes. Even once they have more discretionary income, they might not come back to the market the way that they had historically.” Chinese nationals accounted for around a third of revenues for luxury companies and accounted for more than 50% of the sector’s growth from 2003 to 2019, according to Morgan Stanley. Bank of America analyst Ashley Wallace said the decade from 2002 to 2012 can even be defined as “the China luxury boom” as Chinese demand for luxury goods surged. A post-pandemic spending surge led to luxury stocks such as LVMH to reach all-time highs in early 2023, but that soon changed. The country is now experiencing “the worst consumer down-cycle since China’s entry into the WTO in 2001” as demand shocks and deflation weigh on the economy, said Wallace. “Consumer confidence in mainland China today is back in line with the all-time low reached during Covid,” LVMH Chief Financial Officer Jean-Jacques Guiony said Tuesday during the company’s July quarter earnings call. The company reported a 3% decline in organic growth in the third quarter. Margin pressure across the sector and muted revenue growth in the broader luxury sector will likely continue into next year as Chinese consumer sentiment remains low, according to BofA forecasts. “The slowdown in consumption is only just materializing in 3Q24. We believe improved confidence and sentiment is required to reach even our flat year-over-year Chinese luxury growth forecast for 2025,” Wallace noted. Luxury stocks are feeling the pressure — year to date, U.S.-traded shares of major players LVMH and Kering are down about 17% and 41%, respectively. Moncler has dropped 2.3%. Traditionally defensive name Hermes is up 7% for the year, which still significantly lags the S & P 500 ‘s 23% gain. Prada has bucked the trend, gaining 24%, while Richemont added nearly 7% year to date. LVMUY CFRUY,.SPX YTD mountain U.S.-traded shares of LVMH and Richemont against the S & P 500 in 2024 ‘A great wall of money’ China’s recent stimulus rollout — which includes measures such as financial support for real estate, interest rate cuts and looser property purchase rules — sent Chinese stocks on a roller coaster. It wasn’t just Chinese companies that experienced an initial surge, however; luxury stocks also rallied 16% in the initial days following the stimulus news, per Bank of America. However, when subsequent announcements by Chinese government officials underwhelmed investors and sparked a heavy selloff in mainland Chinese markets, luxury stocks fell in tandem. To be sure, additional property sector measures have been announced since, as well as fiscal stimulus, spurring more investment and consumption. Analysts and investors are mixed as to whether the Chinese stimulus measures can revive luxury spending growth among consumers — and whether it will create a meaningful tailwind for luxury companies. Initiatives such as lowering the interest rate for bank deposits could spur greater spending. Chinese consumers tend to have a far higher average savings rate of 31% compared with just around 4% in the U.S. This means there is about $21 trillion in household savings, which means over the long-term, the luxury sector still has room for more penetration and growth in China. A deployment of a “great wall of money” could be sparked, Morgan Stanley analyst Edouard Aubin wrote in a client note on Sept. 12. However, some investors are more skeptical on the actual impact the stimulus measures will have for luxury goods. While “improved equity market, property and economic outlook could indirectly prop up consumer confidence which in turn would be positive for luxury. We don’t expect the fiscal support to target a luxury customer,” Wallace said. Back to ‘bullish exuberance’? It’s not just economic overhangs that could reduce Chinese consumers’ spending on luxury goods. Consumer tastes and habits have been changing over the last few years. The property sector woes and underperforming stock market led to households saving their money, beginning a “consumption downgrade narrative, where Chinese consumers focus more on domestic brands,” according to Core Values’ Harburg. Consumers have started to engage in “import substitution,” where they purchase domestic alternatives to foreign brands in areas such as clothing, cosmetics and automobiles. The queues for luxury stores in Chinese malls are not as long anymore as they were pre-pandemic, he added. While Harburg’s fund is long only, he said if he could, he would be short on the luxury giants with these shifts in Chinese consumer trends. The Chinese government’s anti-corruption crackdown targeting high-ranking officials and wealthy individuals has led to less ostentatious and obvious shows of wealth. This has created a trickle-down trend where the upper middle and middle class don’t have the same demand for luxury goods and status markers. “You don’t want to have the eye of Sauron turned toward you,” Harburg said. “The Chinese consumer summed up is cautious and conservative. They just don’t have that kind of bullish exuberance to go out and splash money irrationally or emotionally, because there’s uncertainty.” Whether the luxury sector can continue growing at the same levels without as much Chinese consumer spending remains in question. Luxury brands may have to rely more upon smaller luxury markets, which will likely lead to lower margins for the sector. “It’s normal that people are asking [if] this is totally structural and will never come back exactly the same way. Maybe,” LVMH’s Guiony said. “But we are still very hopeful that the luxury industry will continue to develop and sort of surf on the wave of the emergence of the upper-middle class as we’ve been doing over the last 55 years.”

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