Quarterly Outlook
Macro outlook: Trump 2.0: Can the US have its cake and eat it, too?
John J. Hardy
Global Head of Macro Strategy
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Luxury stocks do not care about China’s old economy
Peter Garnry
Chief Investment Strategist
Summary: Our luxury theme basket is up 32% over the past year as investors have bet heavily on this part of the equity market to benefit the most from the Chinese reopening. While commodities have not responded the way many investors thought would happen the consumer spending in China has picked up and that change in the Chinese economy seems to what the market correctly captured with its bet on luxury. We also take a look at the longer term risks to luxury and finally we also highlight the green transformation as this theme is the worst performing the past year due to higher interest rates and high electricity prices.
Key points in this equity note:
- Luxury is the best performing equity theme basket the past year and the preferred bet on China by global investors
- The key risk to luxury is the fragmentation game as it could drive nationalistic policies unfavourable for Western companies in China
- The worst performing equity theme basket the past year has been green transformation as electricity as become expensive and interest rates are still high
Is China changing in a way that benefits consumption over commodities?
Take a look at the 1-year performance among our equity theme baskets. It shows a super league of themes consisting of luxury, defence, and construction. The last two themes are about the world fragmenting leading to massive military buildout in Europe and significant investments in infrastructure globally. The third theme mentioned is luxury which has been the most hot equity theme this year up 21% in 2023 and 32% over the past year and a theme we introduced back in February in our introduction note Luxury is a resilient growth industry in the age of inflation. Yesterday, we wrote about Swiss-based luxury company Richemont which is scheduled to report earnings on Friday and expected to sound upbeat on the future given the guidance we have seen from other luxury companies such as LVMH and Hermes.
Why is luxury doing so well given we are getting news after news explaining why the Chinese rebound is weak? The answer deserves length, but today we will provide the short answer. China’s heavy investment-driven economic model is running out of steam and in a fragmentation game China must pivot to become a more consumer oriented economy. This is already happening and this seen in China’s consumer spending figures and results from consumer oriented companies. The high beta of this trend, but also a function of the reopening, is luxury goods and the market has therefore correctly anticipated this change in China betting on those stocks instead of the classic move of getting exposure to resource oriented companies.
The key long-term risk to luxury is geopolitical fragmentation
While luxury stocks are conquering equity markets these days and will continue to deliver strong results in years to come there is a slow-moving underlying risk that has to be appreciated by investors. The fragmentation game that we wrote about in our Q2 Quarterly Outlook is deep at its core about two value systems, liberal democracies and authoritarian states, breaking from their growing dependence during the last period of globalisation. This fragmentation will lead to nationalistic policies in many regions including China and the risk for luxury companies is that China will emphasize national consumer companies including luxury and potentially strengthen its own culture at the expense of “Western culture” linked with the luxury industry.
The green transformation has suffered the most over the past year
While the green transformation theme was the most powerful theme back in 2020 it has been the worst performing theme the past year as higher interest rates have crushed valuations and slowed activity. It is important to acknowledge that the green transformation is a capital intensive transition and thus higher interest rates will make the green transformation more expensive but also slower in terms of its adoption. Key in the green transformation is the electrification of transportation and heating, but one of the key risks in this transformation is our electric grid and this could become a critical bottleneck in the years to come. Read our equity note The little-known risk to the green transformation from last month on this topic.
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