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