The US employment market recently delivered a new warning sign of a forthcoming recession, but it is questionable whether it will already take hold this year because economic activity in the USA still appears to be robust. There are much clearer adverse signals emanating from the manufacturing sector in Europe, where Germany looks set to stay in negative growth territory this summer. Meanwhile, the global rate-hiking cycle is nearing its end.
The real estate market was China’s golden goose for years, but has since become the Achilles’ heel of the Middle Kingdom’s economy. In light of demographic and geopolitical challenges, and given concerns about financial stability, the government of China no longer views the real estate sector as an all-purpose automatic growth engine. That’s why in spite of a mediocre economic outlook, a renewed round of heave-ho real estate sector stimulus is unlikely to occur in the near future.
Nothing stirs investor sentiment as much as market prices do. In the wake of a lengthy rally, sentiment on equity markets in recent weeks has accordingly gone from depressed and wary to cautiously optimistic for a
while and from there most recently to mildly overheated and euphoric about AI. The near-term risk/reward tradeoff has worsened in any case, so investors would be well advised to position themselves a bit more defensively or to think about a hedging strategy.
The market for luxury goods has long since pulled out of its COVID trough. The rising middle class in China and other emerging economies as well as younger generations’ altered consumption habits look set to drive a continuation of constantly increasing demand for (expensive) extravagance in the years ahead. The luxury industry’s practically crisis-proof growth story remains intact and promises further outperformance potential in the long run.
In the wake of greenwashing scandals and a period of relatively weaker performance, many investors are viewing “sustainable” investment strategies a bit more sober-mindedly than before. Although it has become widely recognized that one doesn’t necessarily have to sacrifice returns with ESG-compliant investments, conversely there is also mounting evidence that “green” doesn’t automatically generate an outperformance. Mutual fund managers in the USA likewise appear to realize this.
Artificial intelligence is on the rise and will substantially change the world (of work) in the years ahead. Although the AI revolution will probably wipe out some jobs, it may create new job profiles and thus more jobs (and more prosperity) on aggregate just like similarly disruptive inventions have in the past. At any rate, generative large language models like ChatGPT will likely make the work of financial journalists and analysts easier because by now they are even capable of deciphering one of the most mystifying linguistic enigmas in the world of finance: the US Federal Reserve Board’s comments on its interest-rate decisions. ChatGPT-3 was already able to interpretively classify the nuances of Fedspeak utterances between “dovish” and “hawkish” similarly as well as humans can. The latest large language models, however, now even articulate “good-as-human” reasonings for their classifications.
Stuttering economic activity (in some places) and very evidently receding inflation rates won’t make central bankers’ work easier in the months ahead, nor will they make it easier to communicate monetary policy.
The US employment market recently delivered a new warning sign of a forthcoming recession, but it is questionable whether it will already take hold this year. There are much clearer adverse signals emanating from the manufacturing sector in Europe, where Germany looks set to stay in negative growth territory this summer.
Different growth speeds
The USA and Europe are growing at different speeds (again) this year. Economic activity in the United States for the first half of 2023 held up better than expected. More and more economists are now pushing their forecasts of the dreaded recession ever farther into the future and, like us, don’t expect the downturn to occur until next year. However, economic indicators remain contradictory. The US housing market has stabilized lately and investment spending is picking up thanks to the Inflation Reduction Act and the CHIPS Act, but the labor market has recently been flashing warning signs: initial unemployment insurance claims are up more than 10% compared to the prior quarter – over the last 50 years, this has consistently heralded a recession.
Stark sentiment divide
Growth in the Eurozone, meanwhile, is already in a lower gear, particularly in Germany. After the country initially had appeared to get through winter better than expected, Germany’s Federal Statistical Office significantly lowered the GDP growth figures for Q4 2022 and Q1 2023. The business activity and sentiment surveys published in June now portend an even longer dry spell. The manufacturing purchasing managers’ index and the Ifo index both fell significantly and came in lower
than expected. At the same time, Germany’s heretofore resilient services sector has also been showing signs of weakness lately as falling real wages and the German government’s somewhat chaotically orchestrated green transition have pummeled consumer confidence.
Rate-hiking cycle almost over
Major central banks around the world jacked their policy rates higher again in June. Stuttering economic activity (in some places) and very evidently receding inflation rates won’t make central bankers’ work easier in the months ahead, nor will they make it easier to communicate monetary policy. In view of this challenge, most central banks are making the future interest-rate path contingent on upcoming macroeconomic data –forward guidance has outlived its usefulness. On the basis of the current data, the Swiss National Bank, the European Central Bank, and the Bank of England look set to tighten the interest-rate screw at least one more time. The US Federal Reserve likewise sees an even higher policy rate in its latest projections, but the Fed is the central bank closest to the end of the rate-hiking cycle.
A gap to close | The services sector looks set to converge downward Differential between Eurozone services and manufacturing purchasing managers’ indices
The real estate market, which has transformed in recent years from a proverbial golden goose to the Achilles’ heel of Chinese economic activity, is one of the main reasons why China’s policymakers are keeping a foot on the growth brake.
The real estate market was China’s golden goose for years, but has since become the Achilles’ heel of the Middle Kingdom’s economy. In light of demographic and geopolitical challenges, and given concerns about financial stability, the government of China no longer views the real estate sector as an all-purpose automatic growth engine. That’s why in spite of a mediocre economic outlook, a renewed round of heave-ho real estate sector stimulus is unlikely to occur in the near future. On the contrary, the formerly booming Chinese real estate market faces a pronounced L-shaped trajectory going forward.
For many economists, it was a foregone conclusion that there would be a vigorous upturn in spring after the lifting of pandemic containment restrictions and the turbulent reopening of China’s economy in the middle of winter. And in fact, the growth data for the first quarter did surprise on the upside, as did the government’s quite ambitious new growth target of +5% for 2023. Lately, however, the Chinese growth locomotive has already started to sputter again and some macroeconomic data points have recently disappointed. We are sticking with our assertion made back in spring 2022 that China will drop out as the main driver of global economic activity in the future (see “Will China come to the world’s aid?”
[Link zum Artikel]). In fact, a lot more air looks set to escape from the world economy’s former life preserver ring over the coming quarters or, more likely, years. Instead of serving up stimulus with a giant ladle once more as it has done so often in the past, the government of China will likely try “merely” to stabilize the country’s future growth path and to limit the downside risks by implementing narrowly targeted support measures here
and there. The People’s Bank of China’s interest-rate cuts in mid-June fall into this category of “homeopathic dosing”.
The real estate market, which has transformed in recent years from a proverbial golden goose to the Achilles’ heel of Chinese economic activity, is one of the main reasons why China’s policymakers are keeping a foot on the growth brake. The role that the real estate sector played in China’s growth and prosperity model over the past two decades was indeed extraordinary – and unusual:
• Economic growth and employment: Ever since the great financial crisis of 2008/2009, if not before, China’s economic growth has become less and less driven by exports and increasingly fueled by investment spending. In the course of this shift, the real estate industry was the most important sector by far. For more than two decades, it made a disproportionally large contribution to economic growth – depending on the way it is calcu-
Once a growth engine, now a problem | China’s real estate sector is (too) huge Real estate-related economic sectors’ share of gross domestic product
Sources:
lated (or including upstream and downstream sectors as well), the real estate sector recently accounted for one-quarter to one-third of China’s total economic output. It not only built housing for millions of Chinese, but also created millions upon millions of jobs.
• Land sales and tax revenue: Prices for land in China have exploded by a factor of 64 since 2005. Local governments in China generate a substantial part of their revenue by selling building plots. The real estate market thus indirectly contributes to the funding of infrastructure projects and public services
.• Wealth formation and social mobility: For many Chinese, owning real estate is one of the few ways available to build and invest wealth. Moreover, owning property is considered a status symbol and a pathway to social mobility. Families often invest their entire life savings to acquire real estate in the hopes of boosting their social status
.• Soft power and geopolitical influence: China’s experience and expertise in the real estate sector have been exported around the world through initiatives like the New Silk Road. This has enabled China to strengthen its
geopolitical clout, particularly in developing countries.
For a long time, the interaction of all of these factors created a partially self-reinforcing virtuous cycle of more growth, rising property prices and mounting confidence, more consumption, and greater prosperity. Last but not least, the government used the real estate market as a veritable automatic growth machine whenever the need arose. More than once, the real estate sector was the tool that re-kickstarted China’s economic growth just at the right moment, because rising property prices boost consumer confidence and business sentiment, which leads to greater consumption and increased investment. The government particularly cranked up this economic activity lever in the year 2015, when the People’s Bank of China unleashed a flood of liquidity totaling CNY 3.4 trillion to promote home ownership among low-income families and to reduce the oversupply of housing. This sparked a spike in demand for housing, which in turn stimulated supply and caused real estate prices in many Tier 2 (medium-sized) and Tier 3 (small) cities to more than double since then at their peak.
It not only built housing for millions of Chinese, but also created millions upon millions of jobs.
Sources:
At the end of the 2010s decade, if not before, China’s success model started to show more and more cracks and increasingly revealed its downsides.
At the end of the 2010s decade, if not before, China’s success model started to show more and more cracks and increasingly revealed its downsides. The speculation-driven construction boom resulted in vacancy rates well above 20% on average. Deserted ghost cities were left behind as colossal monuments to economic inefficiency. Ever-spiraling prices made buying a home practically unaffordable for young families and at the same time widened the divide between property owners and non-owners. Property prices increasingly became detached from the economic fundamentals, and a wide array of statistics (see charts below) made it recognizable to even laymen that China’s real estate miracle was arguably perhaps just a bubble. Environmental pollution and strains on natural resources likewise belonged to the negative side of the coin. But above all, the rapidly mounting debt loads of real estate developers and local governments posed ever-increasing risks to China’s financial stability, which ultimately made the ever more perilous risks more relevant to the central government. These risks were probably one of the prime reasons behind Chinese President Xi Jinping’s drastic U-turn.
In August 2020, he announced his “three red lines” for property developers (more equity capital, leverage limit, raised minimum liquidity ratio), triggering an earthquake in the real estate market (including bankruptcies of many real estate companies) that is still causing aftershocks to this day.
The government enacted further measures in addition to the “three red lines”. For example, a cap was placed on the number of properties that a single person can acquire. Moreover, minimum down payment requirements for real estate purchases were raised, and stricter mortgage lending guidelines were implemented. Xi Jinping put the government’s policy realignment with regard to the real estate market in a nutshell three years ago in his mantra “houses are built to be inhabited, not for speculation.” This stance is still valid today because China, at the same time, finds itself confronted with demographic and geopolitical challenges. China’s fertility rate has dropped to 1.3 children per woman (only South Korea, Taiwan, Italy, and Singapore have lower birth rates), and the country’s population is on pace
to rapidly (over)age. Multiple studies have found that young adults in China are deciding today against having children due to the high cost of educating them and particularly in view of expensive housing costs. Better housing affordability for the masses thus has a high priority for the senior leadership of the Chinese Communist Party. Greater affordability could be achieved not just through higher wages, but also through stagnant or further mildly declining real estate prices. Meanwhile, in the context of the geopolitical situation and especially the rivalry with the USA, the leadership of China sees itself in an era of “struggle” and is less tolerant than before of excesses and bubbles that could burst at any moment. It instead wants China’s economy and financial system to be “grounded” as much as possible so that it can resist adverse shocks, including external ones (e.g. US sanctions).
Averting a downward spiral in the real estate sector is a top priority for the government in the quarters ahead. However, there will be no return to the heave-ho real estate market stimulus of past years in the interest of avoiding renewed excesses in any event. The support measures implemented for the real estate sector thus far (including loans to property developers) should also be read in that light. They aim, first and foremost, to bring initiated construction projects to completion so that the citizens who already paid for their new condominiums in advance (which was the case in 90% of the projects prior to the crisis!) can finally live in them. Business involving entirely new real estate projects continues to lie idle, in contrast. Despite selective liquidity injections, many property developers remain in dire financial straits. Citizens, for instance, are no longer willing to pay in advance for their dreams that exist only on paper. And there is also only meager demand now on the part of local governments – their long-gushing source of revenue from the sale of building plots is increasingly drying up. The central government will probably continue to be able to close only part of the resulting financing gaps in the future. Weaker real esta-
te developers will drop out of the market. Meanwhile, those banks that are still issuing loans at the government’s behest will most likely almost inevitably incur losses and will thus absorb part of the value destruction in the Chinese real estate sector. Altogether, there’s a lot suggesting that the current real estate market slump is structural and not cyclical. If the government doesn’t make another U-turn, which we believe is what’s most likely to happen, the industry risks sinking into a multiyear malaise in the shape of a pronounced “L”, at the end of which looms a China less dependent than before on the real estate sector. Sporadic stimulus and easing measures will likely continue to be forthcoming, but will tend to serve more as a means of managing downside risks than as a catalyst for sparking a new boom. The same goes for potential further interest-rate cuts like the ones in recent weeks because although mortgage rates recently fell to a 14-year low, people in China are hardly buying real estate in the present situation. Quite the contrary, they are actually even paying down their mortgage debt, not just because consumer debt is already high anyway and the economic outlook is uncertain, but particularly also because the carry trade on the Chinese real estate market is definitively over. It worked only as long as the Chinese could count on a continual increase in property prices that outpaced mortgage rates. But that era is history now. The real estate industry’s immense size and importance also dims the prospects for China’s entire economy. From next year onward, even a growth level of +5% could prove to be too high a hurdle for China to clear.
If the government doesn’t make another U-turn, which we believe is what’s most likely to happen, the industry risks sinking into a multiyear malaise in the shape of a pronounced “L”, at the end of which looms a China less dependent than before on the real estate sector.
Asset
Fixed Income
Equities
Europe
Microfinance UK
Inflation-linked bonds
High-yield bonds
Emerging-market bonds
Insurance-linked bonds
Convertible bonds
Duration
Currencies
US dollar
Swiss franc
Euro
British pound
Equities: The bears throw in the towel
• The past several weeks have proven once more that hardly anything has a bigger influence on investor sentiment than market prices do. In the wake of the torrid rally in (US) technology stocks in the second quarter, which, nota bene, propelled the Nasdaq 100 index to its best-ever performance for the first six months of a year, the bears definitively threw in the towel. Bulls have now clearly been in the majority since June among US retail investors and American investment newsletter authors alike. Another driver of the months-long rally – investors’ light positioning in stocks – has recently returned to normal and is unlikely to continue exerting the same amount of upward thrust in the second half of this year. Now that the VIX volatility barometer has recently been hovering at a level as low as just 13 at times, reflecting pronounced investor complacency, the weeks ahead could get a bit bumpier on the equity market in the middle of the summer news doldrums. The risk/reward tradeoff has worsened lately in any case.
USA
Japan
Emerging markets
Alternative Assets
Gold
Real estate
Hedge funds
Structured products
Private equity
Private credit
Nothing stirs investor sentiment as much as market prices do. In the wake of a lengthy rally, sentiment on equity markets in recent weeks has accordingly gone from depressed and wary to cautiously optimistic for a while and from there most recently to mildly overheated and euphoric about AI. The near-term risk/reward tradeoff has worsened in any case. Scorecard -
+ Macro Monetary/fiscal policy Corporate earnings Valuation
Trend
Investor sentiment
multiple expansion. At a forward price-to-earnings multiple of almost 20x, the broad US market (S&P 500) in particular is already very expensive in historical comparison. While consensus earnings estimates for 2023 have already become more or less realistic and imply flat corporate profits for this year, analysts are still very optimistic about 2024. The current profit growth forecast of almost +10% for the world equity market (MSCI World) harbors potential for disappointment on the downside, in our opinion. Another persistent critical factor is the narrow market breadth, which is most glaringly evident on the US market, but also prevails elsewhere. The 15 biggest stocks in the S&P 500 index are up by approximately a third year-to-date, whereas the median
Kaiser Partner Privatbank AG | Monthly Market Monitor - July 2023 13
Investors would be well advised to take profits on the recent high flyers and to position their portfolios a bit more defensively going forward.
performance of all stocks in the US blue-chip index has merely been flat thus far this year. The top 15 stocks in Europe are up 9% year-to-date while the median performance of all stocks there is likewise much lower at just +4% for the year thus far.
• Investors would be well advised to take profits on the recent high flyers and to position their portfolios a bit more defensively going forward. Stocks sensitive to changes in economic activity look destined to have a tougher time in the near term, especially if deteriorating economic conditions cause bond yields to fall. Defensive sectors like consumer staples and healthcare, on the other hand, could outperform in such an environment, which would also make the recently sluggish Swiss equity market, with its typically low beta, more attractive again.
Fixed income: Government bonds offer an asymmetric risk profile
market investments. The effect of inflation additionally impacts the price of gold because the recent pullback in inflation has also driven up real interest rates, which explains the recent dip in the price of the yellow precious metal. Interest rates have had a smaller influence on the alternative currencies in the crypto universe. Bitcoin’s 20%-plus rally in June was driven much more by news reports that BlackRock, the world’s largest asset manager, had filed an application for permission from the US Securities Exchange Commission to launch a Bitcoin ETF. But among the alternative asset categories, private credit is also a clear beneficiary of higher interest-rate levels. Due to the variable interest-bearing nature of private credit, any increases in policy rates to which interest benchmarks for private loans (such as the Secured Overnight Financing Rate (SOFR)) are pegged land directly in the pockets of investors.
On the one hand, inflation has substantially pulled back from its peak and the risks to economic activity are on the downside. On the other hand, though, central-bank officials have not yet communicated an end to the rate-hiking cycle, and the US Federal Reserve has at most signaled merely a pause.
• The Bank of England’s 50-basis-point policy rate hike in June was the exception to the rule. Other central banks (the Fed, the ECB, and the SNB) tightened the interest-rate screw only by a quarter of a percentage point, as most observers had expected. This hardly left any notable marks on long-term yields, which for weeks have been hovering around the 3.7% level for 10-year US Treasury notes and at around the 2.4% level for German Bunds. The tightly rangebound yield movements reflect market drivers that are balancing each other out at the moment. On the one hand, inflation has substantially pulled back from its peak and the risks to economic activity are on the downside. On the other hand, though, central-bank officials have not yet communicated an end to the rate-hiking cycle, and the US Federal Reserve has at most signaled merely a pause. This means that there is still an opportunity right now to bump up the allocation to government bonds in portfolios at attractive conditions to strap on a parachute for an adverse macroeconomic scenario. In any event, the important thing is to keep a cool head in another hot summer. June registered a resumption of net outflows from US money market funds for the first time in eight weeks, which means that the euphoria has recently also gripped fixed-income markets. Investors would be well advised not to chase this “hot” money.
• Rising policy interest rates and bond yields have a differing effect on each asset class, including within the universe of alternative assets. Increases in bond yields are detrimental to real estate and gold because they reduce those assets’ attractiveness relative to interest-bearing securities and cause the opportunity cost of holding them to rise relative to money
Currencies: Interest-rate speculation is the main driver of exchange rates at present
• EUR/USD: The global rate-hiking cycle is currently in its final stage. The European Central Bank is still lagging a bit behind the Fed and looks set to at least implement another small rate hike in July. Anticipation of a narrowing interest-rate differential caused the EUR/USD exchange rate to turn around and head back upward toward the 1.10 level in June. We, however, do not see much further upside potential beyond the year-to-date high of 1.11. The weak macroeconomic dynamics in the Eurozone argue against the euro. Even in the event of a US recession, the euro would be at a disadvantage due to its cyclical characteristics.
• GBP/USD: The surprisingly sharp policy rate hike by the Bank of England in June lifted the British pound to a new year-to-date high of 1.28 against the greenback. Over the longer term, though, the aggressive actions by the UK’s central bank, which could provoke a hard landing of the British economy, threaten to boomerang. A necessary swift move to undo the latest rate hikes in the event of a hard landing would substantially hurt the pound. But the current combination of interest-rate momentum and a cheap valuation is still a positive for sterling for the time being.
• EUR/CHF: The governing board of the Swiss National Bank wasn’t out to spring a surprise with its latest interest-rate decision and opted for a small policy rate hike, as expected, but that presumably doesn’t mark the end of the road yet. Although inflation in Switzerland has pulled back to a level just north of 2%, the SNB, unlike most other central banks that are pursuing a 2% inflation target, is striving to whittle inflation down to a little above the 0% line. A stronger nominal Swiss franc exchange rate against the euro would help to reach that goal.
In the last issue of Monthly Market Monitor, our “Chart in the Spotlight” cast an eye on the narrow market breadth on the US equity market. In the wake of the rally in recent months, the ten biggest stocks in the market-cap-weighted S&P 500 now make up more than 30% of the overall index, which is a new record. The equal-weighted S&P 500 index has now caught up a bit in recent weeks on the back of a rebound by small- and mid-cap stocks. This jibes with the very long-term trend – the performances of both indices over the last 20 years are practically dead even – as well as with the theory that shares of smaller-cap companies shouldn’t underperform (but instead should outperform) in the long run thanks to their faster growth and superior growth potential. This “law” has been suspended temporarily by the current AI hype, but the statistics suggest that the force of gravity will soon start to apply again to the top 10 because it becomes difficult to lastingly outperform once a stock joins the pantheon of the titans.
Big is beautiful? | It gets progressively harder for behemoth stocks to outperform Average annual outperformance of US stocks before and after joining the top 10
The market for luxury goods has long since pulled out of its COVID trough. The rising middle class in China and other emerging economies as well as younger generations’ altered consumption habits look set to drive a continuation of constantly increasing demand for (expensive) extravagance in the years ahead. The luxury industry’s practically crisis-proof growth story remains intact and promises further outperformance potential in the long run. In the near term, though, some advance laurels are already priced in, so there’s no urgent need for investors to rush into the sector.
The European equity market has more or less treaded in place thus far in the second quarter. This salutary breather thus far follows on the heels of a torrid 30%-plus rise during the prior half-year, which was driven in large part by the luxury goods sector, an industry that for once is not dominated by the USA, but which instead is led by European companies like LVMH, Hermès, Kering, Luxottica, Burberry, and Richemont. The rally not only lifted France’s luxury-heavy CAC 40 blue-chip index to a new all-time high, but also produced a host of other records. In April, for instance, LVMH (Moët Hennessy Louis Vuitton) – the luxury goods conglomerate that owns the rights to 75 different brands – became the first European corporation to attain a market capitalization of USD 500 billion. The group’s founder, the French national Bernard Arnault, thereafter was the world’s richest person (temporarily), ahead of Tesla CEO Elon Musk. LVMH thus also put a European company back in the ranks of the world’s ten largest enterprises, at least for a few weeks. These records are the fruits of a long-running growth story. LVMH’s stock price has
climbed from EUR 81 per share at the start of 2010 to as high as over EUR 900 at its peak thus far. When Mr. Arnault at LVMH’s last shareholders’ meeting was confronted with a proposal for a stock split to optically make the group’s stock price more affordable, he had a firm opinion about the idea. He replied that desirability is proportional to value and added that LVMH shares are also a luxury product themselves.
LVMH’s founder thus himself described one of the formulas of the luxury goods industry’s success: artificial scarcity that makes products even more desirable for a certain clientele and justifies correspondingly high prices. It’s precisely this clientele composed of the very wealthy and superrich that has fueled this largely crisis-proof growth for more than a decade now because the purchasing power of this cohort is virtually inexhaustible and its shopping behavior is almost entirely unaffected by economic cycles, inflation, or geopolitical tensions. Moreover, demand among this group of consumers is extremely inelastic – an increase in prices
The more exclusive, the better | Luxury has many facets Global luxury market (all categories), in EUR billion
Sources: Bain & Company, Kaiser Partner Privatbank
hardly results in a noticeable decrease in unit sales or does so only in the event of drastic price hikes. Since the great financial crisis of 2009, the market for luxury goods (i.e. personal luxury goods in the narrow sense, such as leather goods, apparel, footwear, cosmetics, watches, jewelry) has expanded by around 7% per annum to a 2022 sales volume of EUR 353 billion. Yet, not even the luxury industry was immune to the COVID-19 pandemic. However, the 22% contraction in the luxury goods market wasn’t caused by the coronavirus recession per se, but was the result of lockdowns and the collapse in tourist traffic and also owed to supply-chain and production bottlenecks. That’s why the subsequent recovery was accordingly swift and V-shaped. From the low 2020 base, the market for luxury goods expanded at an average annual growth rate of 26% over the last two years. The comparatively late, but in turn all the more dynamic reopening of China’s economy at the
end of last year drove the most recent burst of growth, which was also reflected in the latest stellar quarterly figures posted by the big luxury goods manufacturers. LVMH reported a 14% increase in sales in Asia for the first three months of 2023 while rival Hermès registered a whopping 23% jump in sales there.
…in the future as well
These excellent growth figures for the past several quarters obviously reflect a certain degree of pent-up consumer demand. But even without such one-off effects, there is still considerable growth potential in the pipeline for the years ahead. Consultancy firm Bain & Company’s latest industry study projects an average annual growth rate of 5% to 6% for the luxury goods market until the end of this decade. The forecasted growth isn’t based solely on the desires of the top 1% of the wealth pyramid, composed of people who are
Pandemic dent long since smoothed out | Steady growth expected to continue in the years ahead Global market for luxury goods, in EUR billion
Since the great financial crisis of 2009, the market for luxury goods has expanded by around 7% per annum to a 2022 sales volume of EUR 353 billion.
Sources: Bain & Company, Kaiser Partner Privatbank
China’s expanding middle class continues to make that country the number-one growth market for luxury brands for the time being.
China remains a growth engine | Good prospects for luxury goods despite macroeconomic challenges
Share of global luxury goods market by consumer nationality and region, EUR billion
known to plunk down EUR 20,000 at the sales counter for (a slot on the waiting list for) signature bags. An equally meaningful growth factor is the global middle class, regardless of whether in industrialized or emerging economies, because the luxury industry manufactures products not just for the superrich. In fact, it addresses each class of customers individually, including even a wide swath of “emerging customers” who are willing to spend 1,500 euros on a Petit Sac Plat handbag from Louis Vuitton (and to perhaps cut other spending elsewhere to afford that). China’s expanding middle class continues to make that country the number-one growth market for luxury brands for the time being. In the year 2000, the middle class (as defined by the OECD) accounted for only 7% of China’s population, but its demographic share has since increased to 30% or over 400 million people in the meantime, making it larger today than the entire population of the United States. Half of China’s population will likely belong to the middle class by 2030. And by that point in time, India, too, will become increasingly interesting and relevant as a further growth area. India’s population is on track to swell to 1.7 billion by 2050, and the country’s aggregate household income will likely have increased
by a factor of 13 by then. More than a billion Indians are likely to belong to the middle class by as soon as 2039, by the OECD’s definition. Even if only a fraction of that mass of people were to become luxury goods enthusiasts, the potential for the luxury industry would be immense. Finally, changing consumption habits in industrialized countries are a third growth driver for the luxury industry. According to the study by Bain & Company, people are buying personal luxury goods at an ever younger age. The study found that members of Generation Z have started to buy luxury items three to five years earlier than their predecessor generation (Millennials) did. There are multilayered causes behind this trend, probably also including the fact that the rise in housing prices and interest rates has made it increasingly harder for the younger generation (in contrast to baby boomers or Gen X) to climb the real estate ladder these days. Falling birth rates are also changing consumption behavior. To put it bluntly, young adults are spending less money today on mortgage interest payments, diapers, and baby food, and are splurging more on affordable luxury goods.
The luxury goods industry thus promises a lot of growth potential for many more years to come, which should also translate into (even) higher stock prices in the long run. At the same time, shares of luxury goods manufacturers are one of the few remaining attractive indirect plays on China, which – viewed objectively – is facing major domestic-policy challenges (housing market, demographics) and foreign-policy difficulties (rivalry with the West, Taiwan issue). Looking at the near term, however, lots of advance laurels for things like the reopening of China’s economy and the corresponding pent-up demand among Chinese consumers are now already priced into luxury goods stocks in the wake of their sparkling performance lately. Moreover, it’s becoming increasingly apparent that mounting
wage pressure and other factors may chip away at leading luxury goods companies’ record-high profit margins. Finally, it’s unlikely that the performance of luxury goods stocks can completely decouple from the broad European equity market, which currently appears headed for at least a consolidation, if not a mild correction, because the European Central Bank recently has reiterated its hawkish tone and is still far away from pivoting on monetary policy. Meanwhile, from a technical analysis perspective, the recent breather on European stock markets has not yet been enough to relieve the overbought condition signaled by the momentum indicators. So, there’s no reason for those investors who wish to partake in the luxury trend to hurry. It’s more advisable to enter the sector gradually and/or to make larger-scale stock acquisitions on dips.
In the meantime, though, the green investment universe is no longer unconditionally being viewed through rose-tinted glasses.
In the wake of greenwashing scandals and a period of relatively weaker performance, many investors are viewing “sustainable” investment strategies a bit more sober-mindedly than before. Although it has become widely recognized that one doesn’t necessarily have to sacrifice returns with ESG-compliant investments, conversely there is also mounting evidence that “green” doesn’t automatically generate an outperformance. US Mutual fund managers likewise appear to realize this.
Preferably not ESG when one’s own money is at stake Do mutual fund managers believe in ESG? Not all that long ago, that acronym used to get uttered in the same breath with “outperformance” and/or “lower risk”, or in any case with “a better risk-adjusted return” compared to conventional investment strategies. In the meantime, though, the green investment universe is no longer unconditionally being viewed through rose-tinted glasses. Nevertheless, it would be interesting to find out how it is really seen by those professionals who handle billions each day and are ultimately responsible for the investment decisions in the portfolios of institutional or wealthy private clients. A study published in February by the University of St. Gallen* investigated precisely this question using a sample of 1,273 broadly diversified, actively managed mutual funds in the USA. The study specifically examined whether mutual fund managers who invest their own money in the strategy or product that they manage bet more or less on stocks that have good sustainability ratings. The design of the study was based on an underlying understanding that managers who have skin in the game invest in line with their own utility function and, in so doing, disclose their own belief systems, thus also in relation to sustainability investing. Similarly structured studies in the past have already shown that portfolio managers who have their own money at stake in their funds bet less frequently on lottery-like (highly speculative) stocks, take fewer risks, and tend to deliver a better risk-adjusted performance compared to other managers. The fin-
dings of the latest investigation may astonish you: the portfolios run by mutual fund managers who have skin in the game exhibit lower ESG scores – the higher the amount of a managers’ own capital invested, the poorer the ESG performance. When managerial ownership in funds was increased, holdings of ESG-oriented companies in portfolios were further reduced. Moreover, co-investing managers tended to overweight stocks with problematic ESG issues and to underweight stocks with no ESG controversies or risks.
The negative correlation between a manager committing his own money to the investment strategy he runs and the sustainability attributes of the stocks selected gives reason to suspect that US mutual fund managers do not believe that ESG criteria produce a performance-boosting effect. Why, then, are sustainability funds enjoying constant net capital inflows, and why are new ESG investment products continually coming onto the market? The trend appears to be driven from two sides. On the one hand, investors have been exhibiting a steadily growing interest in the sustainability theme for years now. Many would like to use their investment capital to make a contribution to a more sustainable future. The fact that their earnest desire is being exploited by a number of black sheep in the mutual fund industry to promise investors a green pie in the sky is an adverse side effect of the ESG megatrend. In any event, the vibrant demand on the part of
investors is a principal cause of the growing supply of ESG investment products. On the other hand, investment products in a sustainability wrapper are also attractive for the financial industry because they can be sold to the public at significantly higher prices in some cases. It’s a poorly kept secret in the industry that ESG perhaps does less good for mankind and our environment than predominantly gets promised, but is above all lucrative. The study by the University of St. Gallen confirms that incentives ultimately have a co-determining influence for or against an ESG tilt because although US mutual fund managers do not appear to be great believers in ESG, they nevertheless invest comparatively more in stocks with high ESG ratings if their
compensation depends on the size of the assets under management in their respective investment products. They thus are well aware of the marketing impact of ESG. On the other hand, if a mutual fund manager’s compensation depends solely on the performance of the investment product (versus a defined benchmark, for example), the manager invests less in stocks with good ESG scores.
What does this analysis – which refers exclusively to the US market, mind you – imply for investors? It suggests that whoever wishes to invest sustainably must be aware of the risk that his or her needs may not be adequately met by some fund managers if they pursue their own interests due to corresponding incentive structures. The study also makes it clear yet again that investors should definitely be conscious about the costs of ESG products. In our view, sustainability-oriented portfolios should not be significantly more expensive than conventional strategies. Moreover, one can avoid the fund industry’s conflicts of interests by choosing providers that preclude misincentives right from the outset. Kaiser Partner Privatbank belongs to this category of independent asset managers. We differ from the fund industry not just with regard to potential conflicts of interests, but unlike the mutual fund managers described above, we also firmly believe that a resolute ESG strategy can reduce investment risks and enables investors to earn a superior risk-adjusted return.
In our view, sustainability-oriented portfolios should not be significantly more expensive than conventional strategies.
* V. Orlov, S. Ramelli, A.F. Wagner: Revealed Beliefs about Responsible Investing: Evidence from Mutual Fund Managers• July 20: International Moon Day
Continuous innovation and the achievements of private space exploration companies are making outer space ever more accessible to humankind. At the same time, space has turned into another theater for the rivalry between China and the West, which is taking place also in the form of new missions to the moon. International Moon Day, which was officially declared in 2021, serves not least to send a call for sustainable new exploration on the surface of Earth’s satellite.
• July 23 to 30: Tour de France Femmes
After being discontinued in 2009, it took more than a decade until a Tour de France for women finally was held again last year. This year’s second edition of the Tour de France Femmes covers 956 kilometers in eight stages, starting in the Auvergne region (in Clermont-Ferrand) and ending with an individual time trial near the Pyrenees (in Pau).
• July 27: ECB policy meeting
In the middle of the summer news doldrums, the European Central Bank looks set to tighten the interest-rate screw once more toward the end of July. Afterwards it will likely shift to wait-and-see mode because inflation has long since passed its peak in the Eurozone as well now and the impacts of the more restrictive monetary policy are becoming visible in rising macroeconomic data points.
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