Luxury stocks on the rise: China news set the trend

After luxury stocks rose significantly by 18.0% in January - outperforming the broad equity indices (Stoxx 600 +6.7%, S&P 500 +6.2%) - the sector fell over the course of February. However, at the close on Friday (10/02/2023), luxury stocks were still up more than 15% year-to-date. While broad-based cyclical trends don’t seem to have a big impact on the luxury sector, the news-flow coming from China has largely dictated momentum so far in 2023. Initially, the sudden turnaround in China's Covid policy - which has the potential to spur a revival in Chinese demand for foreign luxury brands - boosted the popularity of luxury stocks. Then, in early February, geopolitical tensions between the U.S. and China, which had been escalating since late January over a spy balloon, weakened luxury brand prices.

The lifting of travel restrictions to China spurred euphoria among well-known luxury labels. Similar post-Covid growth prospects had driven the steep upward trend of many European luxury brands earlier this year. Despite the positive sentiment driving the luxury sector’s rally, analysts and industry representatives warn against too much optimism. After all, before China’s borders were closed due to the pandemic in early 2020, Chinese customers were buying 70% of their luxury goods abroad. In the wake of the Corona pandemic, the market share of Chinese consumers worldwide declined to just over twenty percent. Furthermore, according to a Bain analysis, the Chinese luxury market declined by 10% year-on-year, ending a five-year period of strong growth. Chinese demand is not expected to return to full force, as travel restrictions have led to a boom in domestic business. This positive trend for domestic luxury boutiques is unlikely to completely end in 2023. Part of the reason for this shift in consumer demand is that some demand is being met by offshore duty-free shopping, for example via trips to the island province of Hainan. In addition, the Chinese government's measures to reduce import tariffs on luxury goods in 2018 and 2019 have dampened the incentive for price-conscious customers to shop abroad. With luxury brands such as Burberry, Gucci and Louis Vuitton having prepared for this scenario by expanding their presence in mainland China, domestic purchases are likely to remain the new normal. Bain reports that Chinese demand, which accounts for between 15% and 35% of major luxury goods companies such as LVMH, Hermès, Richemont and Moncler, will pick up in 2023 but is unlikely to bounce back to pre ‘Zero-Covid’ policy levels until the end of 2023.

Luxury goods companies’ recent publications for the fourth quarter of 2022 show that demand was resilient in 2022 as compared to 2021. Stocks in this sector showed some profit-taking in 2022, while the sector was generally not expected to recover quickly at the end of 2021. As such, growth was driven by one-off factors, such as increased spending of pandemic savings. On average, large brands outperformed smaller market players, with LVMH outperforming notably. Where 2022 was a difficult year for many, it was a record year for LVMH, with both the group's sales and profits growing by double-digit percentages. In addition, LVMH reported almost 14.1 billion euros in profit, 17% more than it did in 2021. LVMH's growth forecasts also appear promising. Buoyed by the encouraging figures, LVMH reached a market capitalization of $400 billion at the beginning of the year, making it the single most valuable company in the eurozone.

In addition to the conventional price drivers such as interest rate decisions and quarterly figures, the current trend in luxury goods stocks since the beginning of February has been determined primarily by the geopolitical tensions between China and the USA. These tensions came to a head last month after the US air force detected and shot down a Chinese balloon it deemed a security risk. U.S. Secretary of State Antony Blinken and Chinese officials quarreled over the incident, with Blinken cancelling his upcoming trip to Beijing. These tensions have had a negative impact on European luxury stocks such as LVMH, Hermès and Richemont, with potential for a continued fall if the conflict continues to intensify.

Reflecting the latest earnings forecasts, the consensus is now expecting a 7% to 8% year-on-year growth in the luxury goods sector, with China driving most of this growth. Analysts believe that the persistent brand strength of luxury in Europe and Asia outside of China could provide some upside. The difficult situation in China and subdued growth in the U.S. could limit the scope of this growth, in large part because of the demand destruction that some developed countries have experienced as a result of high inflation.

Co-written by Cécile Buchholz.