Underpinned by resurgent demand from Chinese consumers as Covid restrictions continue to ease, the outlook for luxury stocks is holding up, writes Christopher Rossbach, portfolio manager of the J. Stern & Co. World Stars Global Equity Fund.
During a recent visit to Beijing, our team saw a bustling capital city, returning to normality after China’s lengthy lockdown. Public transport was busy, roads jam-packed with cars, shops did brisk business, and restaurants were full of diners.
Living through nearly three years of Covid restrictions, Chinese consumers accumulated significant excess savings. We estimate that up to RMB12tn ($1.64tn), equivalent to 10 per cent of GDP, has been saved by consumers during the pandemic. These excess savings are now being unleashed, just as they were in the US and Europe after restrictions were lifted. The re-opening is fuelling spending on discretionary, services, travel and cross-border duty-free shopping. Luxury goods companies like LVMH and Hermès are major beneficiaries of these excess savings.
LVMH has long been a major portfolio holding and will continue to be, despite its share price recently drifting lower. There are widespread concerns that post-pandemic economic recovery in China is faltering. There are numerous challenges and recovery is never a straight line. Everybody likes to call a bottom. But in our view, concerns will prove short-lived and the market underestimates the breadth of levers at Beijing’s disposal to support the economy through stimulus programmes.
Geopolitical instability
Challenges to companies doing business in China include geopolitical instability, (with Taiwan and Russia of particular note, plus tensions with the US and Europe. Concerns have also been voiced about China’s high youth unemployment, but we believe this is cyclical rather than structural.
China is emerging from three years of lockdown and economic recovery post re-opening has been uneven and below expectations. It is not a surprise that employment growth is slow, with a wave of new graduates leaving university this summer compounding the problem. However, following a late-summer flurry of official measures to re-ignite growth, the trend should correct itself with better GDP numbers in coming quarters.
The government’s initiatives to stimulate the economy include targeting the property sector, reducing mortgage down payments and interest rates, as well as relaxation of property purchase criteria across tier-one cities. Together with interest rate and stamp duty cuts on stock purchase, and raising personal income tax allowances, consumer confidence and spending will receive a boost. In the long term, China wants to double numbers of middle-income earners to 800m by 2035, adding a pool of consumers the size of the US or Europe.
This may take time to achieve meaningful impact, but we are seeing green shoots emerging from month-on-month stabilisation in property sales and better-than-expected August manufacturing numbers.
One positive driver for the luxury sector has been ‘travel retail’, recovering strongly in Asia, led by Chinese tourists to neighbouring countries. The price differential of luxury goods between mainland China and elsewhere can be 30-40 per cent. The luxury sector could be poised for further inflection following lifting of suspension of tour groups to more than 70 countries, including the US and UK. Attracted by more competitive prices at duty-free outlets, Chinese consumers are among top spenders when they travel, with luxury goods companies primed to capitalise.
Iconic handbags
LVMH is better positioned than many to weather the near-term global macro headwinds. Its recent share price fall is, in our view, an overreaction. Its valuation continues to be supportive, suggesting the wall of worries has been priced in. Hermès has also delivered exceptional results, trading at a price/earnings ratio of 41.5x (2024), reflecting a unique business model and brand positioning, helped by capacity constraints and a waiting list for iconic handbags. In an uncertain environment, the French design house is one of the most resilient luxury companies, deserving to be traded at a premium to the sector.
The long-term narrative on the luxury sector remains unchanged. Growth continues to be powered by structural demand, pinned on aspiration of consumers to own luxury brands, by the rise of the middle class in emerging markets, and strong brand equity and pricing power.
The re-opening of China should prove a catalyst for the sector. Chinese consumers had been the engine of growth pre-pandemic, accounting for almost a third of all luxury demand. The recovery of Chinese consumer spending is still at an early stage. But despite likely normalisation of demand from US and European consumers, in the coming year we expect acceleration of growth in the sector. The key to this renewed trend will most likely be our old friend – the Chinese consumer.
Christopher Rossbach is portfolio manager of the J. Stern & Co. World Stars Global Equity Fund.
