Big bet on luxury stocks stumbles on inflation, China woes

A warning from the chairman of Cartier-owner Compagnie Financière Richemont SA that stubborn inflation was starting to affect demand in Europe prompted a swoon in luxury stocks last week.

That downbeat message added to a string of worrying economic signals from China and signs of softer trends in the United States.

It’s all testing investors’ faith in this pricey sector and raising questions about the theory that luxury stocks are Europe’s strongest response to Wall Street’s high-flying tech stocks. Some US$180 billion has already been wiped out since a recent peak in July, leaving gains for the year hanging by a thread.

LVMH Moët Hennessy Louis Vuitton SE accounted for about 60 per cent of that slump alone and the maker of Louis Vuitton bags got overtaken by drugmaker Novo Nordisk A/S as Europe’s largest company in the process.

A stuttering recovery in China, the source of as much as a fifth of European luxury retailers’ sales, has dealt the biggest blow to the sector. But the malaise has spread to the high-end shopping districts of Paris, Madrid and London.

“In Europe, ongoing inflation is starting to impact local demand,” Rupert told Richemont shareholders at its annual meeting in Geneva on Sept. 6.

“What we are seeing on luxury is the end of a consensual ‘long,’ ” said Gilles Guibout at Axa Investment Managers SA in Paris, referring to a rush by investors toward this sector in the first half of the year. “Europe is typically very sensitive to world growth and this is hurting luxury as there is evidence of a slowdown.”

Guibout has an underweight position on luxury and doesn’t plan to buy the stocks until a further pullback makes them more attractive.

The latest survey of China’s services industries revealed more negative data for luxury names, with the slowest expansion this year in August. That suggests the nation’s consumers aren’t optimistic about their future income because of the faltering economy and are tending to save rather than spend.

And soaring bond yields have proved bruising for a group of companies that, like technology firms, relies heavily on capital for expansion and benefits from low interest rates. Benchmark U.S. Treasury yields hit the highest level since 2007 in August, dealing a further blow to sentiment on the stocks.

LVMH chief executive Bernard Arnault’s status as the world’s wealthiest person has been a high-profile casualty of the 15 per cent slump in an MSCI Inc. index of luxury stocks since mid-july. His wealth has dropped to US$170.4 billion as of Sept. 7 from an all-time high of US$212.4 billion. Still, the French businessman has continued a history of purchasing shares in LVMH, buying about Us$230-million worth of stock since late July, according to regulatory filings.

For other investors, the sector’s high valuations leave little tolerance for any disappointments. The MSCI Europe Textiles Apparel & Luxury Goods Index trades at 24 times projected earnings, above its historical averages and a massive 90-per-cent-plus premium to benchmark indexes.

Bruno Vacossin at Palatine Asset Management, said this is a good time to trim holdings and lock in gains.

“I don’t think that the drivers of luxury stocks are broken, but, simply, the growth trend is weaker,” he said.

Along with worries about Europe’s misfiring economy, where activity is fading while price pressures persist, and a seemingly endless stream of bad news out of China, the latest U.S. earnings season has served up evidence of weakening consumer patterns. In the face of this, analyst projections for luxury companies still look overly optimistic to some investors.

“Many brokers have revised their target prices and I think that the consensus was a little too high,” Vacossin said, adding that he has reduced his positions in LVMH and Hermes International SCA. Those two companies, like Moncler SPA and Swatch Group AG, are expected to post double-digit growth in their current reporting years.

HSBC Holdings PLC analysts broke ranks last week as they cautioned that third-quarter results in luxury are likely to be “soft.” Spending on luxury items in Europe has only recovered to 41 per cent of August 2019 levels, they said, with constraints around flight capacity and visas limiting tourist numbers and adding to local headwinds.

What’s more, technical analysts point to signals suggesting there is a risk that the descent for LVMH and its luxury peers could get worse.

“The underperformance of the sector has a high probability to continue in the coming months,” said Daybyday technical analyst Valerie Gastaldy. “Hermes will be key to the speed of the moves. It is holding up remarkably well, and it may buy some time for the rest of the sector. Yet, overall, risks remain to the downside, both in terms of absolute and relative performance, if we look into the end of the year.”

Analyst projections still don’t reflect such concerns. Their aggregate price targets imply a 25 per cent gain for LVMH over the next year, a 28 per cent increase for Gucci-owner Kering SA and a 9.5 per cent advance for Birkin-bag maker Hermes. By their estimates, the MSCI’S index for the sector offers a potential return of more than 12 per cent.

“The stocks performed well this year, so it makes sense to take some profits,” Vacossin said. “But I think it’s more a tactical move rather than a broad change in trend.”

IN EUROPE, ONGOING INFLATION IS STARTING TO IMPACT LOCAL DEMAND.