Proxy plays on China's consumer rebound are all the rage in Paris

Global luxury companies have been among the biggest beneficiaries of China’s post-lockdown bounce and are delivering investors exposure to the world’s second largest economy without putting money in Chinese companies.

One compelling way to invest in China’s economic rebound doesn’t trace back to the boardrooms of Shanghai or the industrial parks of Shenzhen. Instead, it’s centred 8,000 km away, in the maisons de couture of Paris.

As China has reopened from Covid-era lockdowns, it hasn’t followed up by deploying the hefty state stimulus spending that pushed up deficits in many Western nations in recent years. Instead - and unusually, for China - consumer spending is expected to do much of the heavy lifting in driving the economic recovery this time. While economic activity is clearly seems to be accelerating, the rebound has been both tentative and patchy, leading to an idiosyncratic line-up of sectors and companies set to benefit from the upswing. 

Global luxury goods companies, for example, generated 33 per cent of their sales from Chinese consumers before the pandemic, according to Bain & Company. That dipped to below 20 per cent last year while China stuck with zero-Covid, but the re-opening has sparked a fierce rebound, and these firms have been among the first in line to clip the upside from Chinese consumers’ comeback. Reporting first quarter earnings on April 12, LVMH, whose brands include Louis Vuitton, Christian Dior and Fendi, said its Chinese clientele “leads the charge” in fashion and leather goods sales growth. One Paris-based executive in the sector told us that the start of the year has been “encouraging”, while some industry estimates imply that sales could return to pre-Covid levels in China for the full year.

Consumer proxy plays

Investors have turned to luxury brands, in part, because it’s been viewed as a step removed from China equity market headwinds including the regulatory tightening in recent years in the tech, education and property sectors. While the knock-on effects of these measures to broader consumer confidence didn’t leave luxury unscathed, the sector more recently has most likely benefitted from a deep-pocketed client base that controls a lot of the excess savings accumulated by Chinese households during the pandemic.

The S&P Global Luxury index (which is 80 per cent consumer discretionary and counts LVMH, Richemont, Hermes, Mercedes and Kering as its top constituents) has risen more than both the broad MSCI China equity gauge and the CSI Overseas China Internet index since 2021, the year Chinese per capita domestic consumption recovered and rose 13 per cent in nominal terms, on the back of China’s initial success in containing Covid. A similar picture unfolds when we rebase these indices to the start of this year, after China exited zero-Covid.

Of course, past performance is not a reliable indicator of future performance, and some of that Chinese consumption is now priced in. In fact, the biggest risk to this proxy trade lies in its success. The luxury goods sector’s valuation is at a high with 12-months forward price-to-earnings ratio of over 30x following the recent earnings beat, compared with MSCI China’s PE ratio of 10.6x.

More room to run? 

What comes next? We think outbound tourism, for one, may also prove a ‘proxy’ trades on the rebound. Japan, Korea, and Thailand will welcome a wave of Chinese tourists in the coming weeks - bookings on travel apps for the upcoming week-long May 1 holiday have surged 18 times higher than their levels a year earlier. That will drive sales of cosmetics, food and beverages, hotels and duty free shops. Also on their shopping list could be Australian wine, especially as we expect tensions thaw between the two countries.

The MSCI World with China Exposure Index already offers a basket of ex-China commodities, semiconductors, telecoms companies linked to the Chinese economy. But these names are more remote from the current Chinese economic recovery which, unlike in past cycles, is skewed toward consumption. They have not rallied as much as luxury companies.

The point is that the China opportunity has always been bigger than China. Trades like China proxies offer differentiated risk-return profiles for a potentially broader investor base - one that may find its ideal exposure to China’s growth on a boulevard in Paris, far away from the busy streets of Beijing.