Luxury Brands Navigate China Slowdown and Tariff Pressures

Luxury Brands Navigate China Slowdown and Tariff Pressures

Josh Rubin: Thanks for joining the Thornburg Investment Insights podcast, I’m Josh Rubin, a client portfolio manager at Thornburg.  In the last episode, we began talking about the core tenets of investing in global luxury. And today, we’ll talk more specifically about luxury around the world—what’s happening with luxury buying in China, US consumption, the impact of tariffs, and a variety of other topics. We’re joined by Portfolio Manager Sean Sun, who oversees international equity strategies at Thornburg.

Sean, thanks for joining us.

Sean Sun: Yeah. Thanks for having me, Josh.

Josh Rubin: Why don’t we start by diving into your key takeaways from your trip?

Sean Sun: The trip offered a pretty timely perspective on the sector. You know, while the broader luxury sector is navigating various macroeconomic headwinds like a China slowdown, a bit softer consumer confidence in the U.S., slower cadence of innovation and creativity, and a recent overreliance on price increases post-Covid. I think the core investment thesis remains intact and the valuations look pretty reasonable here.

So, on a secular basis, luxury stocks of compounded growth at attractive rates of return because these are high quality brands built upon hard to replicate intangibles like heritage, exclusivity and desire. And the very top brands have delivered sustainable growth over many, many decades and in some cases, over 100 years. These luxury stocks are very important components of international indices, and this recent trip to Italy helped to underscore the significance.

Josh Rubin: Okay. So let’s talk about China, because I think China, particularly over the last 5 to 10 years, has been a more, challenging or at least volatile part of the luxury market. And if we say China enters the WTO 2003 and you kind of have 10 or 15 years where there’s so many, large cities in China that had a cohort   of wealthy families that were especially building wealth in those early days. So, Louis Vuitton could open a store in two cities in China each year for ten years and just have automatic growth. But now we’re at a point where the Chinese market, it’s not so saturated from a consumption standpoint, but a little bit from store openings, a lot of the major brands, don’t have as much room to run.

And then we’ve obviously had crackdowns from the Chinese government, both around corruption, but also just sort of, the optics of being too wealthy as the Chinese economy is kind of slow. So, talk to us about China, both the challenges and the opportunities there still and.

Sean Sun: Yeah, so historically, China has been you’ve seen a massive amount of wealth creation, within China, as you mentioned, over the decades. The immense growth of the Chinese economy, a lot of people have moved up from, you know, out of poverty into the middle class and into the high-net-worth individual class. And as a result, you know, that that wealth creation has led to quite a bit of spending all across the board, including towards many of these major luxury houses.

I think structurally long-term China’s role is intact when it comes to luxury spending, but more recently, fundamentals have remained, remained relatively muted, I’d say. You know, China recently celebrated their Golden Week holiday in early October. And we spoke to some consultants and experts regarding on the ground performance of various luxury brands during Golden Week, and I’d say the take away, more recently is that things are just okay-ish. Growth is kind of flattish year over year. It’s fine, but there’s no real indication that Chinese demand is inflecting positively in a very strong way yet. And when you look at the key factor behind the recent softness in luxury spending out of the Chinese consumer, it’s the fact that real estate prices have struggled, as we know, over the past few years, and have yet to show any kind of signs of recovery or rebound.

And if you look at what the Chinese government is doing in terms of their efforts at recent stimulus, they’ve also failed to do very much as well. So, to put some numbers on it, the property slump in China has erased an estimated 11 to 12 trillion RMB of household wealth, obviously creating the psychological drag on spending, especially on luxury spending.

But we’re starting to see some positive things coming out of the Chinese economy, most notably on the equity side. So, we’ve seen recent strength in the Chinese stock market, a lot of it coming out of these technology stocks. Part of it is AI enthusiasm and we’ve actually seen equity markets in China add about 15 trillion of capital, market cap, over the recent period.

So, while that creates some hope for an eventual recovery in luxury demand out of China, it’s not quite evident yet, at least looking at the more real time data. But you know what we’ve also seen, and it’s not just limited to China, is that consumers are pivoting a bit more towards experiences away from goods. You know, things like travel, dining, cultural events, etc. And that’s been a bit of a headwind compounded on top of the negative wealth effects from real estate.

Josh Rubin: Okay. And so maybe again, to tie a few things together, number one, just to kind of convert the RMB into dollars kind of a $1.5 trillion headwind from real estate wealth effect. But then we’re on a $2 trillion tailwind from the recent moves in the Chinese equity market. So, from a consumption standpoint, you may feel more comfortable today than you did two years ago about the wealth you’ve built or spending on a little bit of it.

But I think travel is a really underappreciated component of luxury for two reasons. Number one, as you mentioned, there is this question of the tradeoff. Do I want to spend on experiences or on goods? But secondly, is the spending on luxury through duty free. And there’s been a lot of times around the world where we see some arbitrage with wealthier consumers who say, you know, in China they have a luxury tax, I don’t want to pay the luxury tax, but I can offset the cost of an entire trip to France with my savings by not paying the luxury tax, if I buy my luxury that’s in France or maybe today. U.S. consumers don’t want to pay tariffs on European produced luxury goods, and so they’d rather travel to Europe for it.

So, are there any indicators whether, you know, we can really quantify it or just color what we’re hearing in the market about how global travel either again, experiences or because of trade war, taxes, etc., are affecting luxury consumption.

Sean Sun: I really only have like anecdotal evidence, but you’re correct. Consumers of luxury goods tend to be rather sophisticated, and they are smart enough to realize when there are, quote unquote arbitrage opportunities around, avoiding VAT taxes or around currency movements. Actually, we saw that, Japan saw really strong sales of luxury goods, especially from Chinese consumers, as the yen weakened.

Then the yen strengthened and more recently, the yen’s weakened. So we may see a resurgence there. But yes, the there is oftentimes pricing is not uniform globally. And wealthy consumers are very mobile. They can travel all over the place. We’ve seen it with Russians going to Dubai, for instance, and Turkey. So when there is opportunities to purchase the same quality good elsewhere, you’ll often see that, take place.

Also, historically, Chinese consumers were a little bit more wary to buy luxury goods within China because of the risk of counterfeits. So, they would prefer to actually travel abroad to Louis Vuitton’s flagship store on the Champs-Elysees and actually buy they had back there. And like I said, make a vacation out of it as well as actually buy it a bit cheaper than you could in the whole market.

Josh Rubin: Sean, I think when I’m on the road speaking to Thornburg’s clients and we’re talking about investing in international equities, the question I get, no matter what topic we’re really focused on, the question I always get is what’s the impact from tariffs. Maybe first, you know, I think there’s some uncertainty in the US economy overall. We’ve talked about how luxury buyers are less economically sensitive.

So they continue their consumption. But do you have a sense just for US consumption? If American consumers, about a third of the global luxury market are, you know, how material or U.S. consumer or is U.S. luxury consumption to the U.S. economy, should we think of that being a tailwind or a headwind to overall economic growth? But secondly, should we think about tariffs as being, having a meaningful impact on U.S consumption of luxury goods right now?

Sean Sun: While the US consumer is an important part of global luxury, as you mentioned, about a third of all global spending comes from US consumers. And, you know, we had a surge of consumer confidence after the recent elections. And then it’s kind of tapered off a bit with, recent tariff announcements. The great thing about these luxury companies and these price points is the fact that and the consumer base is the fact that they can they have the pricing power.

And if you talk to many of these luxury companies, they’ve been able to pass through the costs of higher tariffs. When you look at the actual cost of goods sold of, say, a Ferrari or a cashmere sweater or some of these other goods, it’s relatively small relative to the final retail price. So, these companies are passing through anywhere from low single digit to mid-single digit price increases to offset the head when of tariffs. And these consumers have so far, been able to absorb it.

Josh Rubin: So, kind of the other amazing alchemy of luxury given this high margin structure is I might sell a luxury bag in the US for 5,000 bucks, but I made it for $500 back in Italy. So, I pay a tariff on that $500 cost, so I don’t have to increase the $5,000 price by 25%. I’m increasing the $500 price by 25% to keep my profitability stable. That’s the secret of high luxury margins and tariffs.

Sean Sun: Yes, yes. Like Brunello themselves talked about the low to mid-single digit price increase in the second half. And that’ll fully offset tariff increases.

Josh Rubin: And these high margins are also like unsold inventory. They’ll just burn it. They’re not going to resell it at TJ Maxx. I’ll just burn it because they don’t actually lose that money. That much money when they get rid of something that’s unsold.

Sean Sun: Yeah. It’s an important part of, maintaining that scarcity, of these luxury goods, which is really an important part of long term, brand equity.

Josh Rubin: Great. Well, Sean, I think in, in these pretty complex times right now, both for global growth, for, geopolitics and global trade, luxury definitely is a differentiated way to have exposure to consumers across the world. So, thanks a lot for sharing these insights with us. And in our next conversation, we’ll talk specifically about your recent trip to Italy, which included a lot of interesting conversations with company management, along with a deeper view of the opportunity set for some specific companies.

Sean Sun: Yeah. Thanks for having me, Josh. My pleasure.