China’s push for “common prosperity”

It used to be that when Wall Street sneezed, international stock markets caught a cold. Since then, the thermometer has moved east. Now it’s China that blows hot and cold on stock prices, at least where luxury is concerned, a situation made abundantly clear in August. There is nothing fortuitous about China’s role as “kingmaker”. The country is already the largest market for luxury goods and forecasters predict that Chinese consumers will account for 50% of global luxury sales in the not too distant future: as early as 2023 for some observers; much later for others. Providing grist to the mill of the latter is the declaration — on August 17th following a meeting of the central committee for financial and economic affairs — by Xi Jinping that “common prosperity is an essential requirement of socialism and a key component of modernisation with Chinese characteristics.”

Wealth gap

Will “common prosperity”, and all that the concept implies regarding the redistribution of wealth, curb Chinese consumers’ appetite for luxury amid concerns that their disposable income could suffer? China’s extraordinary economic surge has created a wealth gap comparable to that in the United States. In its annual survey, Credit Suisse notes that 1% of Chinese own 30.6% of national wealth. China now has more billionaires – in excess of a thousand – than any other country in the world. At the same time, 600 million Chinese live with less than 1,000 yuan (US$ 150) per month; a figure quoted by Prime Minister Li Keqiang at a press conference in May. Regulations introduced in 2020 against tech giants, resented for their dominant position, and criticism aimed at food delivery services that are accused of exploiting millions of workers, show that the drive for common prosperity is to be taken very seriously indeed.

The stock exchange was quick to react. In the days following Xi Jinping’s speech, luxury stock dropped by more than 10%. This plunge in prices — an illustration of financial markets’ hypersensitivity to this type of announcement — should nonetheless be put back into the context of previous months when luxury stock soared. Shares in Swatch Group and in Richemont, for example, progressed by 27% and 45% respectively between January and early August 2021 when the benchmark SMI index rose by barely 13%. Investors chose to pocket their gains while waiting for a clear indication of how China intends to achieve this “common prosperity”. The government has a number of options at its disposal, from reforming the income tax grid to the introduction of a wealth tax, capital gains tax, property tax, inheritance tax, a cap on high salaries, etc.

Largest market for Swiss watches

The answer to these questions, and the effects on consumption, will be of particular interest to watch brands. That the sector was able to make up the drop in shipments due to Covid 19 is largely thanks to China. At CHF 10.6 billion, Swiss watch exports for the first half of 2021 were comparable to those of the first half of 2019 (2020 is not a reliable base for comparison). For these six months, shipments to China shot up 62% with no signs of diminishing in July at +75% compared with 2019. The announcement made by Xi Jinping has put the industry and financial markets on alert. That China’s year-on-year second-quarter GDP growth fell short of expectations at 7.9%, after progressing by 18% in Q1, adds to concerns.

This fall in share prices reflects an anticipated decline in sales and profits for the companies in question. “There will inevitably be a period of permanent uncertainty, which is not conducive to a large increase in the performance of equities in the luxury sector,” comments Jon Cox, analyst at Kepler Cheuvreux. Other financial observers are less alarmist, possibly recalling the anti-graft measures imposed by Xi Jinping at end 2013. During the two difficult years that followed for luxury groups and for Swiss watch brands in particular, stock value fell only a moderate amount, never exceeding ‑17%. According to Atlantic Financial Group, if the Chinese government does decide to tax wealthier households more heavily, luxury consumption could effectively slow down. This could, however, be offset by increased consumption among middle-class consumers with sufficient means to buy branded goods.

“Unprecedented growth”

This analysis is echoed by Daniel Langer, a professor at Pepperdine University in Malibu, California, and CEO of luxury strategy consultancy Équité: “During the last two and a half years, practically all growth in luxury came from China. And the country’s wealthy, highly educated, and entrepreneurial young Chinese Gen-Z and millennial consumers have been the driving force behind this boom. These parameters are not going to worsen. In fact, an additional 400 million consumers will transition from low-income to middle-class or higher over the next ten to fifteen years. These extra customers will significantly grow the Chinese luxury market. And domestic tourist, entertainment and duty-free zones like Hainan will attract additional domestic luxury consumption when borders may reopen in roughly a year. Even if wealth inequality is addressed with fiscal or regulatory measures, it will not change the long-term perspective on the Chinese luxury market. We will see unprecedented growth over the next decade and beyond.”

In the meantime, watch brands have another card up their sleeve. Since January, the US market has proved surprisingly bullish. Exports to the United States grew 22% year-on-year over the first half and 48.5% in July. The UK, France and Germany are also showing signs of recovery. Does this mean a shifting balance of power? One thing is for sure: there is little chance of the Chinese government departing from its strategy to reduce economic reliance on exports and boost consumption, in which case the country looks set to remain the top-ranking market for Swiss watches. Barely fifteen years ago, China was the tenth largest market for Swiss watch exports at CHF 351 million. In 2019 it was worth five times that at almost CHF 2 billion.