Look east to the rising appetite for luxury goods

RUSSIA, China and India may not be countries which evoke images of champagne, jewellery, watches and high-end fashion, but they helped to fuel a vintage year for the luxury goods market in 2006.

Rising disposable income and an eagerness to spend it pushed global sales of luxury goods to a record $150bn last year, according to New York's Telsey Advisory Group. Europe leads the luxury goods market and is home to a number of high-profile and revered brand names. These are companies which we believe are well worth watching closely.

LVMH, the world's largest luxury goods company, headquartered in France, and Swatch, the Swiss watch maker, are two companies which have helped substantiate our positive outlook for the sector.

LVMH's signature brands - Louis Vuitton, Moet & Chandon, Veuve Clicquot, Hennessy, TAG Heuer and Fendi - are among the most prized in the industry, and are ones which should strengthen their position further given likely demand from the emerging markets.

Swatch reported record-breaking annual results in 2006, with its luxury watch brands Omega (a particular favourite among China's discerning consumers), Rado, Longines, Blancpain and Breguet dominating the super-premium markets of Asia.

The attraction of expensive, handmade watches shows no sign of fading, and Swatch is well placed to take advantage of this trend, particularly in light of recent additional investments it has made in the artisans who build watches.

Mounting interest in the 2008 Beijing Olympics, of which Swatch is a key sponsor, is also likely to work in the company's favour.

As we look ahead, we predict the newly affluent regions of Russia, China and India will not only continue to boost the already buoyant wealth spent in the more mature markets but, in some cases, will even become the luxury goods sector's premier clients.

Industry surveys indicate that the Japanese, Europeans and Americans consume approximately 25% of the world's luxury goods each, with China approaching 15% and Russia just over 5%.

But China and India, with their booming economies, and the resource-rich regions of the former Soviet Union have been catching up. More importantly, the Japanese market may be reaching saturation point, and with the US and European economies expected to cool over the coming year - with some analysts unwilling to rule out a full-blown recession in the US - it will be the prosperous and brand-savvy consumers from the emerging markets that will drive the sector.

Indeed, among the annual crop of new millionaires, 90% are from India, China or Russia, according to Jean-Christophe Babin, president and chief executive of TAG Heuer - a statistic which underlines the spending power of these economies.

This surge in affluence is also producing a transformation in attitudes, particularly in India and China, where only a decade ago flagrant displays of prosperity were frowned upon.

Now, though, young Chinese consumers are keen to broadcast their wealth with famous, flashy logos. This appetite for the finer things looks set to grow hand-in-hand with the nation's double-digit economic growth too. If analysts at Goldman Sachs are correct, China will become the world's top consumer of luxury goods by 2015.

The situation is slightly different, though no less encouraging, in Russia. Austerity during communist rule notwithstanding, the country is no stranger to opulent lifestyles, which date back to the time of the tsars and the eminence of the grand houses.

This heritage has made it easier to develop a market for luxury goods - one which, with the famed extravagances of the oligarchs and their ilk, should continue to blossom over the coming years.

Of course, things could go wrong for the sector, particularly if the US economy does indeed slide into recession and the dollar's weakness impairs European exporters further. The greenback has already lost some 11% against the euro since the beginning of last year.

Similarly, the current strength of the euro relative to the yen - which has also experienced a low double-digit depreciation against the euro since January 2006, weighed down by a stagnant Japanese economy - may also give Europe's luxury goods makers reason to pause.

That said, LVMH and others have put in place hedging practices enabling them to limit such risks. For example, should they stand to lose money if the price of a currency they hold declines, they can agree to sell a specified amount of it at a set price in the future, offsetting the risk.

These concerns, though, do not critically dampen our positive outlook for the sector. The economies of the emerging markets, barring a good old-fashioned global recession, should continue to prosper, creating an expanding pool of luxury connoisseurs willing to spend on the star brands of the sector.

More importantly, successful companies recognise the need to constantly evolve their brands, to create that ever more desirable and elusive item that will set the discerning shopper apart from the mass market.

Such strategies will ensure the industry remains vibrant and luxury goods makers will continue to prosper.

Catie Wearmouth is Investment Manager, European Equities, at Scottish Widows Investment Partnership

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