(Bloomberg) — Problems are piling up in Europe’s hot sector.
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A warning by the chairman of Cartier-owner Richemont that stubborn inflation was beginning to affect demand in Europe sent shockwaves through luxury stocks last week. That bearish message added to a range of worrisome economic signals from China and signs of softer trends in the US.
All of this is testing investors’ faith in this expensive sector and raising questions about the notion that luxury stocks are Europe’s strong response to Wall Street’s high-tech stocks. About $180 billion has been wiped off since its peak in July, leaving the year’s gains hanging by a thread. LVMH alone accounts for about 60% of the decline, and Louis Vuitton handbags maker Novo Nordisk A/S has emerged as Europe’s biggest company in the process.
A stuttering recovery in China, the source of a fifth of European luxury retailers’ sales, has hit the sector the hardest. But the pain has spread to high-end markets such as Paris, Madrid and London. “Continued inflation in Europe is beginning to affect local demand,” Rupert told Richmond shareholders at its annual meeting in Geneva on Wednesday.
“What we’re seeing in luxury is the ‘long’ end of deals,” said Gilles Gibaut, portfolio manager at Axa Investments in Paris, citing investors’ rush into the sector in the first half of the year. “Europe is traditionally very sensitive to global growth and there is evidence of a slowdown, so this will hurt luxury.”
Gibout has an underweight position on luxury and does not consider buying stocks until further returns make them more attractive.
The latest survey of China’s service industries showed more negative data for luxury brands, with the slowest expansion in August this year. That indicates that due to the economic downturn, the country’s consumers are less optimistic about their future income and tend to save rather than spend.
And rising bond yields hurt groups like technology companies, which rely on capital to expand and benefit from low interest rates. Benchmark U.S. Treasury yields hit their highest level since 2007 in August, further hurting stocks.
LVMH CEO Bernard Arnault has been named the world’s richest man by MSCI Inc. since mid-July. It was the high-profile victim of a 15% fall in luxury stocks. Arnold’s net worth dropped to $170.4 billion from $212.4 billion as of September 7. Still, the French businessman continued his history of buying shares in LVMH, buying shares worth about 215 million euros ($230 million). In late July, according to regulatory filings.
For other investors, the high valuation of the sector leaves no patience for any disappointment. The MSCI Europe Textiles, Apparel & Luxury Goods index trades at 24 times projected earnings, above its historical averages and at a 90%-plus premium to benchmark indices.
Bruno Vacossin, senior portfolio manager at Paris-based Palatine Asset Management, said this is a good time to trim holdings and lock in profits. “I don’t think the drivers of luxury stocks are broken, but simply the growth trend is weak,” he said.
With activity slowing as price pressures persist, and bad news coming out of China combined with fears of a European misfiring economy, the last US earnings season served as evidence of weakening consumer sentiment. In this scenario, analyst forecasts of luxury companies are still optimistic for some investors.
“A lot of brokers have revised their target prices and I think the deal was a little bit higher,” Vakossin said, adding that he had reduced his positions in LVMH and Hermes. Those two companies, like Moncler SpA and Swatch Group AG, are expected to continue double-digit growth in their current reporting years.
HSBC Holdings Plc said spending on luxury goods in Europe has only recovered to 41 percent from August 2019, with restrictions around flight capacity and visas limiting tourist numbers and adding to regional headwinds.
Moreover, technical analysts point to signs that the downward spiral of LVMH and its luxury peers could worsen.
“The sector’s underperformance is likely to continue in the coming months,” said Valerie Gastaldi, technical analyst at DayByDay. “Hermes will be key to the speed of the movement. It is holding up surprisingly well, and may take some time for the rest of the sector. However, overall, looking at the end of the year, both in terms of absolute and relative performance, risks remain behind.
Analyst share price forecasts still do not reflect such concerns. Their overall price targets point to a 25% gain next year for LVMH, a 28% rise for Gucci-owner Kering and 9.5% growth for Birkin-bag maker Hermes. In their estimation, the MSCI sector index offers a potential return of more than 12 percent.
“The stocks have performed well this year, so it’s worth taking some profits,” Palatine Asset Management’s Vakossin said. But I think it’s more of a tactical move than a broad change in trend.
–With assistance from Angelina Raskovet.
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