Although Europe’s luxury businesses shone brightly at Paris Fashion Week, investors are rethinking their appetite for the stock market in the face of a Chinese slowdown and interest rate uncertainty.

The STOXX Europe Luxury 10 index has just experienced its largest quarterly drop since 2020, after entering 2023 in vogue on prospects of a swift increase in Chinese sales after three years of lockdowns and the post-pandemic U.S. spending spree showing little signs of easing.

Since the end of March, the value of those ten stocks has been reduced by $175 billion as China’s recovery has been rocky and growth has slowed, while high inflation and rising interest rates are causing American consumers to tighten their belts.

“The sector has de-rated sharply in the last 2-3 months, due to a combination of rising interest rates, investor positioning and in anticipation of earnings cuts,” said Bernard Ahkong, co-CIO at UBS O’Connor Global Multi-Strategy Alpha.

Although the “Big 10” luxury index is still up 20% year on year, the third quarter was the worst on record in comparison to the STOXX 600, which declined 2.5%.

According to Ahkong, there is growing anxiety about the prognosis for luxury consumption in the United States, Europe, and China, which is shared by Peter Garnry, head of equities strategy at Saxo Bank.

“The recent decline in European luxury stocks reflects the uncertainty over the European economy and also the uneven growth outlook for the Chinese economy,” Garnry said.

The severity of the situation may become obvious in the coming weeks, when some of Europe’s major luxury conglomerates disclose quarterly earnings, beginning with LVMH on Oct. 10.

Although luxury valuations have declined, they remain significantly higher than the rest of the market. According to LSEG statistics, LVMH’s 12 month forward price-to-earnings ratio is around 21, while Richemont’s is 15.6, compared to about 12 for the STOXX 600.

Nonetheless, as a sign of how their star has faded, Danish pharmaceutical company Novo Nordisk surpassed LVMH as Europe’s most valuable listed business this month.

The end of the French luxury group’s two-and-a-half-year reign was largely attributed to investors’ lack of interest in luxury equities, as well as the growth of Novo’s anti-obesity medicine Wegovy.

Some analysts have become more wary about the luxury market, with UBS lowering its predictions last week to account for the danger of declining Chinese consumption.

Morgan Stanley reduced its 2024 earnings-per-share projection for luxury goods by 6%, while Bank of America reduced its estimate by 7%. According to the report, shoppers in the United States and Europe are spending less than they were before the outbreak.

Luxury fashion spending in the United States was down 16% year on year in July and August, according to credit card statistics.

According to Gerry Fowler, head of European equity strategy and global derivative strategy at UBS, risks in luxury stocks began to emerge in May.

“But we aren’t sure that earnings momentum has yet troughed,” he added.

Despite a shift in consensus, numerous market participants and analysts remain bullish on the long term.

“The sector correction has been overly done,” said analysts at Bernstein, adding that companies like LVMH that are spending on marketing and easing up on price increases are best-placed in an uncertain economic environment.

Gilles Guibout, AXA Investment Managers’ head of European stock strategies, was wary early this year due to sky-high valuations, but is now interested.

“Up to now, luxury names were seen as a place to hide, it was really consensual. That was also the reason why we were not so keen to be overweight at the beginning of the year,” he said.

With values now closer to long-term averages, the sector is more appealing to Guibout, albeit he has maintained his underweight rating since the beginning of 2023.

“We will wait for the quarterly results, which should confirm that there has been a slowdown,” he said.

(Adapted from Reuters.com)