Last week the swiss bank’s report on China highlighted that money supply statistics (chart below) pointed to considerable weakness in China’s economy, and obviously, the latest official Chinese PMI just confirms this weakness.  The bank is of the view that Chinese growth in the medium term will be “hampered by the excesses of the previous cycle (in property, investment and credit creation), the drying up of surplus labour, high raw material costs and the lack of “game-changing” structural reforms.”

Having said that, they analyzed the investment implications of this slowdown and are “really concerned” about high end luxury brands. Here are the reasons they “downgraded” luxury recently:

“1. Unlike European luxury, HK based luxury is beginning to underperform quite sharply. Curiously, our Hong Kong analyst, Gabriel Chan, puts this down in part to the fall in the gold price, given that only 20% luxury companies’ gold holdings have been hedged, in a way that they will have to take losses on the value of their inventories.

2. Relative earnings momentum, though strong, seems to be rolling over

3. Macau casino revenue and HK jewellery sales are slowing in year-on-year terms. Casino revenue growth is already the lowest since our data starts in January 2010

4. Our sector valuation scorecard show luxury is 3.6 standard deviation above its norm (and it is always dangerous to buy things that are 3 standard deviation above their norm; statistically this occurs 1% of the time!).

5. Sell-side analysts’ net buy recommendations are positive

6. Consensus projects 12% revenue growth for this year – yet, at the start of the year growth was 4%

7. Not surprisingly, the gap between materials and luxury has never been this high

8. After the Bo scandal, it is not unlikely that there will be changes in official gifting policy in China. (There could now a stigma associated with high-end luxury). Additionally, it’s probable that there was a correlation between luxury demand and shifting money overseas – and as the capital account is being opened up, this need diminishes.

9. We suspect that luxury was used as a store of wealth (given negative real deposits rates). As real deposit rates rise, there will be less need for this. We find ourselves much more concerned about high end luxury than the low-end.”

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