Myths and Reality of Luxury Demand
The luxury goods industry grows in “waves”, expanding from region to region. It moved from Europe to the USA in the 70s; it conquered Japan in the 80s; it moved into Russia in the 90s; and in the most recent 15 years it rode on the back of massive Chinese development. Understanding how these waves work – especially those appearing in EMs – is of vital importance when it comes to assessing the future shape of luxury demand.
In a rising tide, income inequality fuels luxury demand. Newly rich – starting at the top of the social pyramid – race to fill their wardrobes. They progressively sophisticate, moving to more complex product categories and services. Eventually, they come of age and normalise their spend/ capita. This is what is going on in China at the moment. The bulk of luxury growth is driven by middle class consumers, with shallower pockets and higher attention to price gaps. Besides, the undertow of more muted macro-economic growth hits the rich too.
The outlook for luxury goods is difficult in the near term. Structural moderation by the Chinese – one of the largest “waves” luxury goods have enjoyed in their modern history – compounds a subdued global macro-economic environment
It seems wise to seek cover and to lean on the side of prudence when it comes to luxury goods exposure, as long as the environment stays this difficult – and as long as the industry hasn’t fully adjusted to a “new normal” of more moderate growth. We think the preferred option is to invest in self-help stories with high probability of success and only partial market appreciation:
1) Kering is our top pick;
2) Hugo Boss is cheap, but has so far underwhelmed; hopes hinge on digital;
3) Burberry is probably the most intriguing of our Neutralrated names at the moment.
Betting that high quality is cheap enough (CFR) may require mediumterm patience.