China’s clam­p­down is not the end of the lux­ury boom

The Daily Telegraph - Business - - Business | Comment - GARRY WHITE Garry White is chief in­vest­ment com­men­ta­tor at wealth man­ager Charles Stan­ley

Has Don­ald Trump killed Ver­sace? The US ad­min­is­tra­tion’s trade war has started to hit global mar­kets, with shares in global lux­ury-goods com­pa­nies such as Burberry, LVMH and Prada lead­ing the slump.

This fol­lowed re­ports that China was crack­ing down on ex­pen­sive items be­ing brought across its bor­ders as it fights back against the im­po­si­tion of tar­iffs. With Chi­nese buy­ers re­spon­si­ble for about a third of lux­ury sales, some share­hold­ers have used the news to sell. Has this pre­sented a buy­ing op­por­tu­nity for con­trar­ian in­vestors?

No na­tion on earth is more im­por­tant to the lux­ury goods sec­tor than China. Ac­cord­ing to mar­ket re­searcher Bain, Chi­nese lux­ury spend­ing ac­counted for 32pc of the global lux­ury mar­ket in 2017.

As with many things to­day, re­cent con­cerns were sparked by so­cial me­dia. Last week, videos of bor­der guards search­ing suit­cases for goods over the duty-free al­lowance of 5,000 yuan (£553) were up­loaded to Chi­nese web­sites.

There were also pho­to­graphs of a cus­toms re­ceipt that showed a levy of 60pc on cer­tain cos­met­ics be­ing brought into the coun­try. China Na­tional Ra­dio also quoted a Shang­hai cus­toms of­fi­cial urg­ing Chi­nese cit­i­zens re­turn­ing from over­seas trips to de­clare goods if they ex­ceeded the tax-ex­empt amount. In­vestors have in­ter­preted this as a new front open­ing up in Trump’s trade war.

Mar­ket play­ers had hoped that the US ad­min­is­tra­tion’s trade spat with China would be de-es­ca­lated be­fore the midterm elec­tions on Nov 6.

This has not come to pass and the is­sue ap­pears to have es­ca­lated, be­com­ing in­ter­twined with China’s ter­ri­to­rial am­bi­tions in the South China Sea and else­where. In­deed, a re­cent speech by Mike Pence prompted some to de­clare the start of a “new Cold War” be­tween the two su­per­pow­ers.

The US vice-pres­i­dent branded China’s at­tempts to gain in­flu­ence in other na­tions through its belt and road ini­tia­tive as “debt diplo­macy” and said the coun­try had a “whole-of-gov­ern­ment” ap­proach to master­mind “the whole­sale theft of Amer­i­can tech­nol­ogy”.

Amer­ica has more lever­age with tar­iffs as it im­ports sub­stan­tially more from China than vice versa. How­ever, China is fight­ing back on a num­ber of dif­fer­ent fronts. The most sig­nif­i­cant of these is the de­val­u­a­tion of the yuan, which is about 11pc weaker against the dol­lar since its April peak. This, to some ex­tent, takes the sting out of tar­iffs on its ex­ports.

How­ever, if this new Cold War es­ca­lates, China will have to be­come more imag­i­na­tive in its re­sponse. This is why its ac­tions tar­get­ing the lux­ury goods sec­tor could be a taste of things to come, al­though bor­der checks will prob­a­bly have a lim­ited im­pact.

Fol­low­ing its third-quar­ter re­sults re­lease on Wed­nes­day, LVMH shares slumped more than 7pc after it con­firmed that cus­toms bor­der checks in China were in­creas­ing. The shares are down around 15pc in the last two weeks. This was de­spite the lux­ury con­glom­er­ate owner of brands in­clud­ing Dom Pérignon, Givenchy, Bul­gari and Fendi post­ing a fore­cast­beat­ing 14pc rise in com­pa­ra­ble sales in its key hand­bags and fash­ion divi­sion. This mat­ters be­cause, prior to the LVMH state­ment, all in­vestors had to go on was anec­do­tal ev­i­dence from so­cial me­dia.

Al­though fear of ad­di­tional cus­tom checks could give Chi­nese tourists pause for thought when buy­ing goods abroad, the most sig­nif­i­cant im­pact re­lates to the yuan. Al­though the slump will help with the price of Chi­nese ex­ports in re­la­tion to tar­iffs, it also means that Chi­nese shop­pers have lost a sig­nif­i­cant amount of pur­chas­ing power abroad.

The IMF this week said that a full-blown trade war would trim about 0.8pc of global growth in 2020. This slow­down in growth will hit cor­po­rate earn­ings glob­ally, and we have al­ready seen in­vestors start to ro­tate from growth shares into value propo­si­tions. This im­plied that earn­ings mul­ti­ples could suf­fer a fur­ther con­trac­tion in com­ing months – es­pe­cially in the lux­ury-goods sec­tor. Lux­ury-goods com­pa­nies tend to trade on high earn­ings mul­ti­ples. For ex­am­ple, even after re­cent falls LVMH is val­ued at more than 21 times for­ward earn­ings. For Burberry the fig­ure is also 21 and for Prada it is 28.

This is why the third-quar­ter US earn­ings sea­son, which kicks off to­day with num­bers from JP Mor­gan, Well Fargo and PNC Fi­nan­cial Ser­vices, will be vi­tal to keep the bull mar­ket in­tact. Com­ments from com­pa­nies on the trade war and the im­pact on fu­ture growth will be pored over in the City and Wall Street. This im­plies more vo­latil­ity in the weeks ahead as the fig­ures are re­leased.

Claims that we are at the start of a new Cold War ap­pear over­cooked, but earn­ings mul­ti­ple con­trac­tion in sec­tors ex­posed to the dis­pute is likely in com­ing weeks.

How­ever, the fu­ture prospects for high-end spend­ing are good. Ac­cord­ing to fore­caster World Data Lab, half the world’s pop­u­la­tion (3.8 bil­lion peo­ple) now have enough dis­pos­able in­come to be classed as mid­dle class or rich. It is these peo­ple who drive de­mand in the global econ­omy.

The fore­caster also cal­cu­lated that al­most nine in ten of the next bil­lion peo­ple to move into the mid­dle class will be Asian. This is bullish for the lux­ury sec­tor over the longer term, de­spite the trou­ble­some head­winds.

‘Chi­nese lux­ury spend­ing ac­counted for 32pc of the global lux­ury mar­ket in 2017’

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