Extravagance in demand

The market for luxury goods has long since pulled out of its COVID trough. The rising middle class in China and other emerging economies as well as younger generations’ altered consumption habits look set to drive a continuation of constantly increasing demand for (expensive) extravagance in the years ahead. The luxury industry’s practically crisis-proof growth story remains intact and promises further outperformance potential in the long run. In the near term, though, some advance laurels are already priced in, so there’s no urgent need for investors to rush into the sector.

Premium in many ways

The European equity market has more or less treaded in place thus far in the second quarter. This salutary breather thus far follows on the heels of a torrid 30%-plus rise during the prior half-year, which was driven in large part by the luxury goods sector, an industry that for once is not dominated by the USA, but which instead is led by European companies like LVMH, Hermès, Kering, Luxottica, Burberry, and Richemont. The rally not only lifted France’s luxury-heavy CAC 40 blue-chip index to a new all-time high, but also produced a host of other records. In April, for instance, LVMH (Moët Hennessy Louis Vuitton) – the luxury goods conglomerate that owns the rights to 75 different brands – became the first European corporation to attain a market capitalization of USD 500 billion. The group’s founder, the French national Bernard Arnault, thereafter was the world’s richest person (temporarily), ahead of Tesla CEO Elon Musk. LVMH thus also put a European company back in the ranks of the world’s ten largest enterprises, at least for a few weeks. These records are the fruits of a long-running growth story. LVMH’s stock price has climbed from EUR 81 per share at the start of 2010 to as high as over EUR 900 at its peak thus far. When Mr. Arnault at LVMH’s last shareholders’ meeting was confronted with a proposal for a stock split to optically make the group’s stock price more affordable, he had a firm opinion about the idea. He replied that desirability is proportional to value and added that LVMH shares are also a luxury product themselves.

Luxury made in Europe | Europe’s first 500-billion-dollar company is not a tech firm

Market capitalization LVMH in USD billion

Sources: Bloomberg, Kaiser Partner Privatbank

Surefire (crisis-proof) growth…

LVMH’s founder thus himself described one of the formulas of the luxury goods industry’s success: artificial scarcity that makes products even more desirable for a certain clientele and justifies correspondingly high prices. It’s precisely this clientele composed of the very wealthy and superrich that has fueled this largely crisis-proof growth for more than a decade now because the purchasing power of this cohort is virtually inexhaustible and its shopping behavior is almost entirely unaffected by economic cycles, inflation, or geopolitical tensions. Moreover, demand among this group of consumers is extremely inelastic – an increase in prices hardly results in a noticeable decrease in unit sales or does so only in the event of drastic price hikes. Since the great financial crisis of 2009, the market for luxury goods (i.e. personal luxury goods in the narrow sense, such as leather goods, apparel, footwear, cosmetics, watches, jewelry) has expanded by around 7% per annum to a 2022 sales volume of EUR 353 billion. Yet, not even the luxury industry was immune to the COVID-19 pandemic. However, the 22% contraction in the luxury goods market wasn’t caused by the coronavirus recession per se, but was the result of lockdowns and the collapse in tourist traffic and also owed to supply-chain and production bottlenecks. That’s why the subsequent recovery was accordingly swift and V-shaped. From the low 2020 base, the market for luxury goods expanded at an average annual growth rate of 26% over the last two years. The comparatively late, but in turn all the more dynamic reopening of China’s economy at the end of last year drove the most recent burst of growth, which was also reflected in the latest stellar quarterly figures posted by the big luxury goods manufacturers. LVMH reported a 14% increase in sales in Asia for the first three months of 2023 while rival Hermès registered a whopping 23% jump in sales there.

The more exclusive, the better | Luxury has many facets

Global luxury market (all categories), in EUR billion

Sources: Bain & Company, Kaiser Partner Privatbank

Pandemic dent long since smoothed out | Steady growth expected to continue in the years ahead

Global market for luxury goods, in EUR billion

Sources: Bain & Company, Kaiser Partner Privatbank

…in the future as well

These excellent growth figures for the past several quarters obviously reflect a certain degree of pent-up consumer demand. But even without such one-off effects, there is still considerable growth potential in the pipeline for the years ahead. Consultancy firm Bain & Company’s latest industry study projects an average annual growth rate of 5% to 6% for the luxury goods market until the end of this decade. The forecasted growth isn’t based solely on the desires of the top 1% of the wealth pyramid, composed of people who are known to plunk down EUR 20,000 at the sales counter for (a slot on the waiting list for) signature bags. An equally meaningful growth factor is the global middle class, regardless of whether in industrialized or emerging economies, because the luxury industry manufactures products not just for the superrich. In fact, it addresses each class of customers individually, including even a wide swath of “emerging customers” who are willing to spend 1,500 euros on a Petit Sac Plat handbag from Louis Vuitton (and to perhaps cut other spending elsewhere to afford that). China’s expanding middle class continues to make that country the number-one growth market for luxury brands for the time being. In the year 2000, the middle class (as defined by the OECD) accounted for only 7% of China’s population, but its demographic share has since increased to 30% or over 400 million people in the meantime, making it larger today than the entire population of the United States. Half of China’s population will likely belong to the middle class by 2030. And by that point in time, India, too, will become increasingly interesting and relevant as a further growth area. India’s population is on track to swell to 1.7 billion by 2050, and the country’s aggregate household income will likely have increased by a factor of 13 by then. More than a billion Indians are likely to belong to the middle class by as soon as 2039, by the OECD’s definition. Even if only a fraction of that mass of people were to become luxury goods enthusiasts, the potential for the luxury industry would be immense. Finally, changing consumption habits in industrialized countries are a third growth driver for the luxury industry. According to the study by Bain & Company, people are buying personal luxury goods at an ever younger age. The study found that members of Generation Z have started to buy luxury items three to five years earlier than their predecessor generation (Millennials) did. There are multilayered causes behind this trend, probably also including the fact that the rise in housing prices and interest rates has made it increasingly harder for the younger generation (in contrast to baby boomers or Gen X) to climb the real estate ladder these days. Falling birth rates are also changing consumption behavior. To put it bluntly, young adults are spending less money today on mortgage interest payments, diapers, and baby food, and are splurging more on affordable luxury goods.

China remains a growth engine | Good prospects for luxury goods despite macroeconomic challenges

Share of global luxury goods market by consumer nationality and region, EUR billion

Sources: Bain & Company, Kaiser Partner Privatbank

Lots of advance laurels already priced into luxury goods stocks

The luxury goods industry thus promises a lot of growth potential for many more years to come, which should also translate into (even) higher stock prices in the long run. At the same time, shares of luxury goods manufacturers are one of the few remaining attractive indirect plays on China, which – viewed objectively – is facing major domestic-policy challenges (housing market, demographics) and foreign-policy difficulties (rivalry with the West, Taiwan issue). Looking at the near term, however, lots of advance laurels for things like the reopening of China’s economy and the corresponding pent-up demand among Chinese consumers are now already priced into luxury goods stocks in the wake of their sparkling performance lately. Moreover, it’s becoming increasingly apparent that mounting wage pressure and other factors may chip away at leading luxury goods companies’ record-high profit margins. Finally, it’s unlikely that the performance of luxury goods stocks can completely decouple from the broad European equity market, which currently appears headed for at least a consolidation, if not a mild correction, because the European Central Bank recently has reiterated its hawkish tone and is still far away from pivoting on monetary policy. Meanwhile, from a technical analysis perspective, the recent breather on European stock markets has not yet been enough to relieve the overbought condition signaled by the momentum indicators. So, there’s no reason for those investors who wish to partake in the luxury trend to hurry. It’s more advisable to enter the sector gradually and/or to make larger-scale stock acquisitions on dips.

Further outperformance potential in the long term… | …but overheated in the near term

Luxury goods stocks vs. consumer goods sector and broad equity market

Sources: Bloomberg, Kaiser Partner Privatbank