Luxury stocks have been riding high for months, fueled by the optimism that the rich would flock back to shopping in China, the world’s second-largest economy. There was also an expectation that affluent consumers would resume traveling abroad to indulge in the finest stores. However, recent evidence of an economic slowdown in China is casting doubt on this narrative.

For instance, Wall Street’s enthusiasm for shares in LVMH (ticker: MC. France), a French company known for its portfolio of high-end brands spanning fashion, fragrances, wine, and watches, has diminished. Previously considered one of the best plays on China’s post-Covid reopening, LVMH is now facing scrutiny.

The initial logic behind this confidence was that wealthy Chinese shoppers would surge back into the market after the country lifted its zero-Covid policy in late December. The hope was that they would resume their role as big spenders, as they were before the pandemic. However, mounting indicators of an economic slowdown have posed a challenge to this narrative.

The decline in Chinese imports and exports indicates a decrease in both international and domestic demand, ringing alarm bells among analysts. A noteworthy event was consumer spending for July experiencing such a significant drop that the country slipped into deflation, highlighting a weakened consumption recovery.

Contrasting with the robust rebounds seen in the United States, Europe, and Japan since their respective Covid-reopenings, China’s macro data suggests a more subdued recovery. Rogerio Fujimori, an analyst at Stifel, summarized this observation, stating that China’s consumption recovery is weaker compared to other major economies.

Despite this, the Chinese government remains determined to achieve a 5% increase in annual gross domestic product (GDP) through stimulus measures. However, analysts and investors regard this growth rate as merely a step towards economic recovery rather than a full-fledged jump-start.

The uncertainty surrounding China’s economic trajectory has exerted pressure on luxury stocks in recent months. LVMH, which encompasses reputable brands such as Tiffany, Dior, and TAG Heuer, serves as a prime example. Its shares have witnessed a decline of over 10% since reaching a peak of 900 euros ($984) in April.

In conclusion, the narrative that luxury stocks would thrive in China’s post-Covid reopening is being challenged due to mounting evidence of an economic slowdown. The weakened consumer spending, declining imports and exports, and a subdued consumption recovery contribute to concerns about the future performance of luxury brands in the Chinese market.

Luxury Sector Faces Challenges

The luxury sector has been experiencing difficulties, with several major companies seeing a decline in their stock value. Cie. Financière Richemont, owner of Montblanc and Cartier, has seen its stock drop nearly 19% since reaching a peak in mid-May. Similarly, Kering, the parent company of Gucci and Balenciaga, has seen its stock decrease by almost 17%. Hermès International, although peaking in late July, has also experienced a loss of over 4% in the past month alone.

Despite these losses and China’s economic slowdown, analysts surveyed by FactSet still rate LVMH, Richemont, Kering, and Hermes as a Buy. In fact, their average target prices suggest potential upsides ranging from 6% to 33%.

One of the reasons behind this optimistic outlook is the importance of the Chinese market. Analysts believe that being exposed to Chinese shoppers is crucial, especially when demand in the US is expected to soften. Missing out on China’s growth is seen as a greater risk than facing China’s economic slowdown.

Fujimori, an analyst at Stifel, believes that Richemont is well-positioned to handle the softening US demand due to the gradual comeback of the Chinese clientele. He rates the stock as a Buy. On the other hand, Jean Danjou from ODDO BHF notes that Kering needs to improve its overall positioning in the Asia-Pacific region and China. He rates the stock as Neutral.

While there are risks associated with a prolonged economic slowdown or financial crisis in China, for now, luxury stocks are simply becoming less popular rather than being seen as an investing mistake.

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