The biggest rally in three years for luxury-goods makers in Europe is fizzling on concern slower economic growth in China and renewed euro-area political turmoil after Greece’s inconclusive election will choke off demand.
The nine-company Bloomberg European Luxury Goods Index, whose clothiers and watchmakers get 34 percent of sales from Asia, tumbled 5.5 percent over the past five days, the largest decline since Nov. 24, data compiled by Bloomberg show. The Stoxx Europe 600 Index retreated 2.5 percent. The luxury gauge surged 25 percent in the first quarter as designers Hugo Boss AG (BOSS) and Salvatore Ferragamo SpA gained more than 50 percent.
China’s cooling growth, the political impasse since Greece’s May 6 election and proposed tax increases from France’s new president are hurting the industry. Francois Hollande, who defeated Nicolas Sarkozy to become the first Socialist in 17 years to control Europe’s second-biggest economy, has proposed a 75 percent levy on incomes above 1 million euros ($1.3 million). Swatch Group AG, the world’s largest watchmaker, gets 38 percent of revenue from China, home to more than a million millionaires, and Burberry Group Plc (BRBY) generates 33 percent of sales in Asia.
“With the growth momentum in China slowing, what has been pushing the luxury-goods sector higher and higher is bound to weaken as well, and luxury companies will see an end of their massive rally,” said John Plassard, a director at Louis Capital Markets SA in Geneva. “2012 will prove itself a transition year.”
The Bloomberg luxury index retreated 3 percent from April 13, when a report showed Chinese gross domestic product trailed forecasts last quarter, through yesterday. That’s three times more than the Stoxx 600, which slipped 0.9 percent. Swatch, Burberry, the U.K.’s largest luxury-goods maker, and Hugo Boss were the gauge’s worst performers in that period. The index rose 0.6 percent today.
The measure tumbled 62 percent from the end of the second quarter of 2007, when Chinese growth was an annualized 14.5 percent, through the first quarter of 2009, when economic expansion bottomed at 6.6 percent, data compiled by Bloomberg show. The Stoxx 600 dropped 57 percent over that period.
The number of dollar millionaire households in China climbed 31 percent in 2010 to 1.11 million, ranking the country third behind the U.S. and Japan, according to a Boston Consulting Group survey released last year.
The rally in luxury stocks has pushed Burberry’s valuation to 19.9 times estimates earnings, compared with a low of 5.5 in November 2008, according to Bloomberg data. Swatch shares have risen to 15.1 times forecast profits from a low of 6.5 and LVMH Moet Hennessy Louis Vuitton SA (MC) has increased to 16.9 times from 8.7. The Stoxx 600 as a whole is trading at 10.5 times projected income, the data show.
“I’ve become more cautious on luxury goods as the valuations don’t look as attractive,” said Peter Braendle, who helps manage $60 billion at Swisscanto Asset Management AG in Zurich. “I’ve reduced positions in recent months to a light buy, down from a strong buy.” Braendle said he would reduce his weighting to neutral if growth in Asia, especially China, slowed further.
China’s economy expanded 8.1 percent in the first quarter, the slowest pace in almost three years. Foreign direct investment sank for a fifth month in March, while house prices fell in a record 37 of China’s 70 cities tracked by the national government.
“Psychologically, if you see the value of your home falling, you’re unlikely to be a strong luxury consumer,” said Lorne Baring, managing director at B Capital SA in Geneva, which oversees almost $500 million. “The worry is that slowing GDP growth in China combined with falling house prices diminish the appetite for luxury goods.”
LVMH, the world’s biggest producer of luxury goods, sank the most in four months on April 18 as Finance Director Jean-Jacques Guiony said Asian tourists are shifting some purchases to Europe, where prices are as much as 47 percent cheaper. The company made 27 percent of revenue in Asia last year.
In response, LVMH is raising prices in Europe even if it puts items such as 2,270-euro Lockit handbags further out of reach for Europeans whose disposable incomes are shrinking. Tourists, mainly from Asia, account for between 35 percent and 60 percent of luxury sales in Europe, according to HSBC Holdings Plc analyst Antoine Belge.
‘Signs of Struggles’
“This effect is likely to be replicated by other luxury groups in Europe and could lead to lower volumes,” Plassard said. “Raising prices in times of a crisis is extremely risky and may show the first signs of struggles for the sector.”
Burberry fell the most in six months on April 17 after reporting quarterly sales that trailed analysts’ estimates. Swatch Chief Executive Officer Nick Hayek said on March 1 that demand in the “very, very high” segment of the Chinese market was slowing. Asia accounted for more than half of Switzerland’s 2011 watch exports.
For Manish Singh, the head of investment at Crossbridge Capital in London, the rally in luxury stocks may continue as China’s central bank acts to stoke the economy. Chinese manufacturing expanded at the fastest pace in a year last month. The Purchasing Managers’ Index (CPMINDX) rose to 53.3 from 53.1 in March, China’s statistics bureau and logistics federation said on May 1. That was the fifth straight reading above the 50 level dividing expansion from contraction.
“China is in for a soft and managed landing, and I’m not worried about slowing growth,” said Singh of Crossbridge Capital, which has more than $2 billion under management. “The PBOC will continue to support the economy with reserve ratio requirement cuts and other liquidity measures. There’s potential for luxury goods to rebound and perhaps even reach new records once it’s evident the slowdown isn’t as bad as many are making it out to be.”
Credit Suisse Group AG cut the luxury goods industry to benchmark from overweight on April 16, with London-based strategist Andrew Garthwaite saying earnings show signs of peaking. The downgrade means the Zurich-based bank is advising investors to no longer hold more of the shares than are represented in benchmark indexes.
Political parties in Greece have been locked in talks to form a government since an inconclusive election on May 6, raising the possibility that another ballot will have to be held as early as next month. In France, Hollande has proposed a 75 percent levy on incomes above 1 million euros a year and raising the income tax to 45 percent for those earnings more than 150,000 euros.
“Discussions on tax increases in France don’t bode well for luxury goods,” said Trung-Tin Nguyen, a hedge-fund manager at TTN AG. “It’s now not only about a debt crisis and austerity measures, but there’s a political risk as well. Investors may opt to take profits after the strong sector performance over the last quarters.”
To contact the reporter on this story: Corinne Gretler in Zurich at email@example.com
To contact the editor responsible for this story: Andrew Rummer at firstname.lastname@example.org