Will China’s middle class save luxury demand from wealth taxes?

The potential for new redistributive policies in China, in the form of heavier taxes on higher income earners and hikes in capital gains or property taxes, may hit high-net-worth individual (HNWI) consumers. However, in our view, this should not overshadow growing demand for luxury goods from the increasingly wealthy Chinese middle class – enabling sales for high-end brands to remain resilient.

Tech, tutoring – are luxury goods next?

At a finance meeting on 17 August Chinese President Xi Jinping called for a “reasonable adjustment of excessive incomes” and encouraged wealthy groups and businesses to give more to society, according to a Jing Daily report.

This year, Xi has also alluded to the importance of ‘’common prosperity,’’ loosely defined as the creation of more fair and inclusive conditions to expand the middle class and address the nation’s rising income disparities.

Disposable income of people in top fifth of Chinese households is more than 10 times higher than those in the bottom fifth, while disposable incomes in cities are two and a half times those of the countryside, according to The Economist, citing official figures.

The Chinese Communist Party’s (CCP’s) aim of achieving common prosperity can be seen as part of the motivation for the authorities’ regulatory action this year – especially lifting pay and improving conditions for gig-economy workers¹. Lowering the income gap between the urban and rural Chinese is also part of the CCP’s current five-year plan.

This focus on the ultra-rich follows the recent regulatory crackdown on the technology and tutoring sectors, which triggered a stock-market sell-off and underscored increasing efforts by the Chinese Government to reimagine the nation’s quality of economic growth in accordance with its own blueprint.

But we believe this short-term volatility should not cloud China’s underlying investment strengths in the long-term. Especially at a time when Chinese stocks have materially underperformed against the global benchmark since their recent peak (see figure 1).

FIG 1. Window of opportunity? Chinese stocks have underperformed recently

Figure 1 Source: LOIM, Data as on 26 August 2021

China’s appetite for luxury

The Chinese consumer represents about 40% of global demand for luxury goods, according to estimates by Goldman Sachs². Q2 earnings reports from high-end consumer brands also pointed to strong retail sales in China, given the reduced mobility of Chinese travellers due to the pandemic.

But some investors are reducing exposure amid the perceived risk of luxury-goods demand being undermined by the potential for new policies targeting wealth redistribution. The luxury sector, as indicated by the S&P Global Luxury Index, was down 6.8% in the week of 17 August compared to the -1.9% return of the MSCI World. European luxury brands have been particularly impacted given their broad exposure to China.

Luxury brands’ middle kingdom

The Chinese Government’s rhetoric may be somewhat reminiscent of the Xi-led crackdown on gifting and lavish consumption that started in 2013. That campaign severely impacted the luxury sector, which took three years to recover. But we expect further regulatory moves to be less impactful.

This is because elite brands are less reliant on HNWI demand. They increasingly generate sales from middle-class and affluent consumers, and have attracted more buyers from the millennial and Gen Z demographic cohorts. To broaden their market base, luxury brands have diversified product ranges and pricing structures accordingly, and complemented their presence in Pudong, central Beijing and other retail hotspots by expanding into lower tier cities and selected e-commerce channels.

This has resulted in middle-class consumers providing the most demand for luxury goods in China, followed by the affluent and then the HNWIs – a trend that has persisted since 2015 (see figure 2).

An additional 400 million consumers are expected to transition from low-income to middle- class or higher over the next 10-15 years and domestic tourist, entertainment and duty-free zones like Hainan could bolster additional domestic luxury consumption when borders likely re-open in a year, according to another Jing Daily report. 

This supports our view that any potential decline in HNWI demand as a result of any new redistributive policies should not diminish the dominant sources of growth for luxury brands in China: middle class and affluent consumers across the country’s cities.
 

FIG 2. Tectonic shifts in China’s luxury demand

Source: Goldman Sachs Equity Research. “Luxury outlook and strategy: Evolve or decline - Kering raised to Buy”. Published 26 September 2016.

LOIM’s luxury exposure through World Brands

As a global, high-conviction equity strategy focused on brands positioned to benefit from long-term consumer trends, our World Brands portfolio has an approximate 10% exposure to pure luxury companies (excluding cosmetics, apparel and sporting goods). This is one of the lowest weightings to the sector on a global basis relative to the portfolio’s history. Overall, the strategy is diversified across brands appealing to the appetite for greater sustainability, digitalisation and wellbeing among consumers.

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