LONDON, United Kingdom — Geopolitical risk is rising. The world’s three biggest economies — China, the EU and the US — could find themselves embroiled in major trade disputes should the more protectionist factions in the Trump administration get their way. As if this wasn’t enough, two — and possibly four — European countries are set to vote in the remainder of 2017 and we cannot rule out the possibility that anti-euro forces could gain sufficient support to cast real doubt on the future existence of the Eurozone itself. These ‘dark cloud’ scenarios pose clear threats to the luxury sector, though some companies are better positioned than others to weather the storm.
Imagine a scenario in which the US officially accuses China of currency manipulation and imposes higher import duties on Chinese goods, then China retaliates with tighter controls on American companies in China and hikes import duties on American products. This is by far the darkest cloud for the luxury goods industry, as one of the likely consequences would be the puncturing of the feel-good factor amongst Chinese consumers. With sales to Chinese consumers accounting for roughly one-third of the global luxury market, anything that hurts their confidence would be felt across the sector, whether or not other countries were dragged into the dispute, as pretty much every significant luxury goods company has high exposure to China. Who looks safest with the lowest proportional exposure to China? Possibly Brunello Cucinelli.
The US is also a key driver of a second dark cloud scenario that threatens to impact the luxury sector, following Trump economic guru Peter Navarro’s accusation that the Eurozone was manipulating its currency to support German exports. This is a sore spot for a US administration with protectionist tendencies and a wide trade gap with Germany. It’s possible that the US could impose import duties on European goods, although some kind of “border adjustment tax” seems much more likely. Either way, the result would be higher prices for consumers, as companies tried to offset at least some of the additional burden, with a knock-on impact on margins as sales volumes slipped.
Who would suffer? Companies with a high sales exposure to the US but with little local manufacturing capacity, for example Luxottica, which manufactures mainly in Italy and China. Brunello Cucinelli and Salvatore Ferragamo also come to mind. LVMH would have the cushion of its local manufacturing operations; it could even gain some small benefit through exports were the US to adopt a border adjustment tax.
Coming back across the Atlantic, the two countries at the very heart of the European Union — France and Germany — will hold general elections later this year; early elections may also be called in Spain and Greece. And though voters in the Netherlands recently rejected the anti-immigration, anti-EU party of Geert Wilders, anti-Europe parties elsewhere in the bloc are on the rise. That they could achieve a governing majority in one of these countries this year seems unlikely, but they could emerge with a strengthened platform for the future. Can the European single currency withstand the democratic test? If voters say no, what would be the consequences for the luxury goods industry?
The short answer is: not bad. Indeed, the wider dislocation of the asset market would create a major opportunity to buy luxury stocks. For a start, luxury goods companies are virtually debt free and so would not suffer the strictures of the banking crisis and credit crunch that would likely ensue. Germany and northern Europe would end up with stronger currencies and lower growth, but these markets are largely irrelevant for personal luxury goods consumption. Southern Europe would likely re-accelerate in time, buoyed by weaker currencies. This should reignite demand from two of the most important European countries to the luxury goods sector: the Italians and the French.
Finally, French and Italian luxury goods companies should benefit from currency weakness, as they are long dollar plays; Swiss and British companies would suffer from adverse currency moves in the short term, but over time the impact for them would be largely neutral. A buying opportunity on the sector, for sure. But I would still go for quality and broad structural appeal, which puts LVMH, Hermès, Luxottica and Richemont at the top of the list.
Luca Solca is the head of luxury goods at BNP Exane Paribas.