China's latest rich list spells bad news for luxury goods

With the number of billionaires falling for the first time in seven years, China's rich are getting poorer. That means things are going to get a lot tougher for luxury goods companies, says John Stepek.

The annual Forbes Rich List came out earlier this month.

The rich list always garners a lot of attention. We're all very curious about wealthy people: who are they? How did they make their money?

But if you were hoping for any shock changes in the running order, you'd have been disappointed. The top ten includes most of the usual faces. And once again the top three consisted of Bill Gates, Warren Buffett, and Carlos Slim (Carlos came top this time).

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There's an arguably much more interesting rich list that hasn't garnered as much attention.

And it speaks volumes about the biggest threat to the global economy today

China's rich are getting poorer

The Hurun Rich List, which tracks China's wealthiest people, came out yesterday.

It makes for a fascinating snapshot of what's going on in China's economy right now. As the Financial Times reports, "many of China's richest people have grown poorer over the past year."

The number of billionaires (in US dollars) has fallen "for the first time in seven years." There are now 251 people in China worth $1bn or more, compared to 271 last year.

That's not a massive change, but it's the direction that's important. And the drop in wealth was widespread. "Nearly half of the 1,000 richest people in China saw their wealth shrink in the past year."

The other interesting point is that, for the first time since the list was launched in 1999, property lost its position as the sector that generated the most wealth. What took its place? Manufacturing.

It's easy to see why property lost pole position. After all, the Chinese government has cracked down on lending in the sector. Property prices have fallen hard in many areas, and the government seems to be keen for the correction to continue.

However, the fact that manufacturing took its place doesn't bode well for China's hopes for rebalancing' its economy. I suspect this is mainly because the property sector has so far fallen harder than manufacturing, but it's only a matter of time.

A riot that shut down a Foxconn factory (Apple's supplier) in northern China earlier this week merely serves to underscore the tensions in the economy just now. Meanwhile, the most recent data showed that the manufacturing sector shrunk for the 11th month in a row in September, according to HSBC's manufacturing index.

So it seems unlikely that manufacturing squeezed between pressure from workers for higher wages, and weak demand from global consumers will be up to producing lots more Chinese billionaires in the near future.

We've been talking about the slowing Chinese economy for some time. We've noted that sliding demand for commodities will hurt miners and the Aussie dollar. That's no longer a controversial view indeed, it's in danger of becoming the mainstream view.

But one area where investors still seem to be sticking their heads in the sand is the luxury goods sector. Despite Burberry's recent profit disappointment, many companies in the sector are still at or near their highs.

Take Hong Kong listed Prada, for example. The share price is up 50% since the company listed last June. As the FT's Lex column points out, it trades at a hefty premium to rivals such as Burberry and Salvatore Ferragamo.

Perhaps that's no surprise. The company is still performing well. In the first half, sales rose 35% and operating profits were up 55%. Chief executive Patrizio Bertelli was cautious, but saw no slowdown.

He told the FT: "The numbers were quite good up to the first three weeks of September but we don't want to push our luck. It's common sense to be cautious right now."

Wise words. Trouble is, given the valuation, investors don't seem to be heeding them.

Avoid luxury goods

People come up with all sorts of excuses as to why luxury goods companies can continue to thrive even when things turn down. They argue that the super-rich aren't price-sensitive they don't feel the pain of recession in the way the rest of us do. Or they argue that certain companies are so exclusive that the rich will always pay up to buy their brands.

But these are classic top of the market' arguments. Clearly, the appetite of the super-wealthy for luxury goods waxes and wanes. In boom times, people are exuberant and keen to flaunt their wealth. In harder times, the desire is to sit on it and not draw attention to yourself.

So we can see how things could easily get a lot tougher for luxury goods firms, even if the global economy doesn't have a catastrophic collapse. The real problem as always is valuation. Luxury goods companies aren't yet priced for a more introspective world.

Even if you buy the arguments that it'll be onwards and upwards for them forever more, there isn't a lot of room for error. As the Lex column notes on Prada: "Burberry has demonstrated that trends can change quickly. Any slip from Prada and there is plenty of scope for a fall."

We prefer to have at least a bit of a safety cushion when we invest. And when times are as uncertain as they are now, we'd rather that safety cushion was quite substantial. So we'd keep avoiding the luxury goods sector. And I'd also be very wary of trophy' assets such as art and wine and the like. If the wealthy don't feel quite as wealthy anymore, these asset classes will be among the hardest hit. You can read more about the assets that we do likein the current issue of MoneyWeek magazine.If you're not already a subscriber, subscribe to MoneyWeek magazine.

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John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.