A Big Tech-like rush into luxury stocks is fast falling out of favor. China got the credit for driving the sectors rally, and now the blame for the pullback.
Red flags that pricey luxury shares have hit a peak are piling up as conviction on the China reopening trade takes a hit. A slew of economic numbers point to a fading recovery, upending a trend thats been central to making LVMH and Hermes International some of Europes favorite stock plays this year.
The countrys shoppers account for about a fifth of the $325 billion global luxury market, PwC estimates, and its weighing all the more now as the US heads for a possible second-half recession. That would dent growth in two key markets.
The fallout has been dramatic. Just a few weeks after becoming the first European company to hit $500 billion in market value, LVMH shares have lost more than $50 billion as investors trim their holdings. Its also hitting the personal fortune of Bernard Arnault, who lost his position as the worlds richest person to Elon Musk, according to the Bloomberg Billionaires Index.
The Stoxx Europe Luxury Index fell almost 5% in May, its first monthly decline this year. That followed a near-50% rally since early October when China reopening bets took off, pushing the valuation multiples of luxury stocks to near-record levels compared with Europes benchmark. Hermes trades at nearly 50 times forward earnings, the same level as Nvidia Corp., the worlds hottest tech stock at the moment.
You have no margin for error at those valuations, said Raphael Thuin, head of capital markets strategies at Tikehau Capital. Buying high valuations is like driving on the highway at 200 miles per hour. Its fine but if something goes wrong, there is a little something on the road or if you are a bit too harsh on the wheel, it can go bad very quickly.
Signs of a slowdown are mounting. China retail sales in April fell short of forecasts, as did industrial production. Reacting to weaker industry surveys, Bloombergs Chief Asia Economist Chang Shu said they increase concern about the strength and sustainability of the recovery.
With the youth unemployment rate at a record high in China, the consumer situation looks increasingly shaky. Big-spending Gen Zs, the prospective buyers of these expensive goods, are already becoming more hesitant, citing the stalling economic recovery.
Thirty-year-old Kathy Nie, who works in Beijing, says she bought luxury bags in the past because everyone seemed to be doing it, but shes not planning any more purchases.
For one thing, the economic situation is not good, so I need to save more money, she said. Furthermore, most luxury brands have raised prices during the pandemic to unacceptable levels.
The selloff in luxury undermines the commonly touted theory that the sectors exposure to wealthy customers keeps them somewhat insulated from economic ups and downs.
At these levels of valuations, I find it hard to tell investors to go for it, said Roland Kaloyan, a strategist at Societe Generale SA. These stocks have boosted portfolios since the beginning of the year and now investors might ask themselves whether the best is behind them, if now is not a good time to take profits and rotate to other sectors.
Hes been wary of the sector for a while, cutting it to neutral in February.
LVMH declined to comment on China, while Hermes didnt respond to e-mails sent by Bloomberg News.
Theres more at stake than just billionaire rankings and revenue growth that now rivals US Big Tech. A sustained decline would undermine broader markets in Europe, especially France. Following their brisk rally since October, luxury giants now account for an outsized proportion of benchmark indexes.
The Chinese reopening is fully priced in and the risk is to find new negative surprises in consumer spending, so all in all it is time to trim those stocks a bit, said Alberto Tocchio, a portfolio manager at Kairos Partners. Valuations are still expensive despite the recent small correction.
For some, China demand will remain resilient even during bad times. China will be no different from the pattern we saw in Japan, said Raj Shant, a client portfolio manager at PGIMs Jennison Associates. Even when growth has gone sideways in Japan, luxury demand kept growing.
His Global Opportunities Fund has Hermes and LVMH among the top 10 holdings.
Meanwhile, economists say more stimulus will be needed to keep the countrys recovery going, although central bank measures alone wont be enough to boost consumer and business confidence.
Elsewhere, the US market is flashing amber, with Swiss watch exports to the biggest market for pricey timepieces falling for the first time in more than two years in April. Cartier maker Richemont has fallen 6% from its all-time high in May, while Swatch is off more than 20% from its March peak.
Kevin Thozet, a member of the investment committee at Carmignac in Paris, says the boom period may have run its course. He however likes the sector over the medium term.
Last weeks movement is a sign that the easy money period is behind us, he said. The upside on the luxury sector is now more limited.
With assistance from Lin Zhu, Charlotte Yang, Michael Msika, Daniela Wei and Angelina Rascouet.
