Global Weekly: Luxury goods under pressure

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Last week, we saw political tensions in Europe weighing more on market sentiment. There is still a lot of uncertainty regarding the outcome of Brexit and the Italian budget deficit talks.

Because of the situation in Italy, the European banking sector underperformed the Eurostoxx 600 index. Over the weekend, the US, Canada and Mexico reached a new trade pact (USMCA), replacing the old NAFTA agreement. In response, cyclical stocks such as Boeing and Intel performed well, making the Dow Jones Index outperform the S&P500 and Nasdaq.

We are now approaching the kick off of the earnings season, with JP Morgan Chase and Citigroup publishing results on 12 October. It will be interesting to see if the existing divergence between the performance of the US and other regions will continue.

There are some signs that the luxury goods market is experiencing some problems, possibly due to speculation that the Chinese government is increasing scrutiny over its citizens importing goods from overseas. This might become important, because a large part of the growth of these companies come from Chinese (and Russian) consumers buying goods overseas. Chinese checks on airports for undeclared goods in excess of the tax exemption amount are being intensified. A continuation of these intensified checks may have a long-lasting effect on growth of luxury goods, hampering this sub-sector. We saw shares of Hermes, Kering (known from Gucci), Richemont, LVMH and Burberry drop by a few percent this week.

Another reason that luxury goods are not doing very well, is that data on traffic growth to Japan, Hong Kong, Macau and Korea shows some moderation. This has more to do with the economic growth of China.

We saw a new ultra-luxury company coming to the market on the London Stock Exchange: Aston Martin Lagonda Global Holdings PLC. Its IPO was not very successful. After a price initially set at GBP 17.50-22.50, it was revised to GBP 18.50-20.00, lowering the midpoint by 75 pence. The IPO price became GBP 19, at the lower end of the range. It subsequently dropped by 4.7% by the day’s close. This had nothing to do with China, but with investors underwriting more than they actually want, as investors usually are allotted less than they want with popular IPOs. If your luck runs out, however, you get the full allotment and you have to sell. That is what happened here.

The difference with Ferrari, that trades at 36 times its earnings, is that Aston Martin is less cash generative and its growth depends more than Ferrari on future models (including the revived Lagonda brand for young Chines and US buyers). Also, Aston Martin’s operating margin lags that of Porsche and Ferrari. The company’s Research & Development is at a higher level because of future models. The launch of the Aston Martin DBX will push margins up. We do not cover the company at this moment yet.

A little less tension

This week, US Treasury yields reached new highs for this year. Trade tensions receded and narrowed more and more towards China. This allowed bond investors to focus more on continuous strength in US growth numbers and a more vigorous tone in recent Fed comments.

As fiscal stimulus will fade in 2019 and inflation remains well contained, we hold on to our expectations that the Fed will stop hiking rates at 3% in June next year. That level should also serve as a guide for 10 year US Treasury yields in the US in 2019. Higher US Treasury yields pushed German Bund yields above 0.5% again, reversing the safe haven effect in response to Italian budget worries earlier in the week.

Italian yields stabilised for now, as a 3% spread levels again managed to persuade the Italian populists to compromise. The Italian government is aware of the huge costs of a euro exit, which only few Italian voters are willing to bear, but are playing a bluffing game with the EU to get more leeway. Volatility and the political power play will continue, as the Italian government is scheduled to present a draft budget to the European Commission by 15 October. We will probably have to be patient before we see spreads below 2% again. At that level, we would start considering to scale back Italian exposure.

The spike in Italian yields has hurt risk appetite and slowed, but not reversed, the positive trend in other risky segments of the bond market. US high yield spreads reached a new low for this decade. Emerging market spreads also resumed their more recent downward trend, as more positive global developments outweighed the impact of increasing political stress in Europe. In addition to Italy, Brexit negotiations are moving towards a climax that could also potentially have some negative impact on the eurozone and its financial markets. Diversification out of Europe is a way to mitigate such risks. Emerging market bonds are still offering attractive yield levels.