April 27, 2023

During the current cost-of-living crisis, consumers are cutting back on spending — but demand for luxury goods remains high. In the fourth quarter of 2022, the luxury market grew 7% organically year-over-year, figures from J.P. Morgan Research show.

“Investors are seemingly turning more constructive on the luxury sector,” observed Chiara Battistini, Head of European Luxury and Sporting Goods at J.P. Morgan. “But while the sector is more resilient, we also note that it has never been immune to macro dynamics and has historically been late cyclical.”

Looking ahead, will ongoing macro uncertainty take a toll on the luxury industry? And will China’s reopening boost the sector’s fortunes? 

“The strength and resilience of the Western consumer in 2022 has been impressive. However, fourth-quarter sales numbers have shown signs of ongoing normalization,” said Battistini. 

In the third edition of J.P. Morgan’s Cost of Living survey, which polled 5,000 consumers across the U.S. and Europe in March 2023, nearly 75% of U.S. consumers said they expect to reduce spending on non-essential goods by at least 6%. European consumers feel less worried about their financial circumstances compared with six months ago, but again, almost 75% expect to decrease discretionary spending by over 6%.

This is partly because consumers are using up the excess savings they accrued during the pandemic. According to J.P. Morgan Research, excess savings in the U.S. peaked at around $2.1 trillion in the second quarter of 2021, decreasing to an estimated $800 billion in the fourth quarter of 2022. This savings cushion is forecast to be fully depleted by the third quarter of 2023. 

Relative to the fourth quarter of 2019, the level of excess savings held by U.S. consumers peaked at almost $2.4 trillion in mid-2021, declining to about $1.7 trillion in the fourth quarter of 2022. It is projected to continue decreasing over time. 

Waning consumer confidence is in turn weighing on sales across most luxury brands covered by J.P. Morgan Research. “Corporates in the U.S. have flagged this is mainly due to American tourists buying more in Europe, but we note that sales growth across both markets is still slowing,” said Battistini. Indeed, the regions’ combined organic sales growth fell to 11% year-over-year in the fourth quarter of 2022, down from 17% in the third quarter.

“Assuming further trend moderations in these two key regions, we would reduce the upside risk to estimates of our regional analysis to 3% on sales and 6–7% on profits,” said Battistini. 

On the other hand, China’s recent reopening is expected to be a tailwind for the sector, especially as Chinese consumers are a major driver of luxury spending. During the 2021 financial year, luxury goods companies generated around 30% of their total sales in Greater China. However, business took a hit during COVID-19, with most brands posting around a 10% decline in sales for the 2022 financial year.

Like consumers elsewhere, Chinese shoppers have accumulated excess savings over the past three years. J.P. Morgan Research estimates that the average saving rate in China was 33.5% in 2022, up from 29.9% in 2019. This, along with pent-up demand, is fueling post-pandemic revenge spending.

Indeed, domestic luxury sales are booming. In January and February 2023, total retail sales in China were up 17% on a four-year stack. There was sequential improvement across all segments tracked by J.P. Morgan Research, including gold and jewelry (+48%), cosmetics (+34%) and apparel (+13%). Demand for luxury timepieces is rising, too: Swiss watch exports to China accelerated to +68% on a four-year stack in February 2023. 

In addition, Chinese consumers are traveling again, which could boost overseas spend on luxury goods. In March 2023, outbound flights to Italy and Korea reached 65.4% and 34.9% of 2019 average levels respectively. However, it remains to be seen if this will drive the luxury sector’s growth, especially as goods in this category have recently become more affordable in China thanks to reduced import duties.

“In our view, the piece of the puzzle that is most difficult to square is how much the return of travel will contribute incrementally to growth, versus cannibalizing the existing sales already taking place domestically,” said Battistini. “We think this should provide more sizeable support to 2024 rather than 2023, given visa requirements and the fact that flight numbers are still relatively subdued.”

Overall, the return of the Chinese consumer looks set to be a huge boon for the luxury industry. “We think that if pent-up demand comes through fully in 2023, luxury companies could post around 35­–40% sales growth in China this year,” said Battistini. 

“While China’s reopening should benefit the whole sector, we expect the magnitude to vary depending on specific brand momentum, with consumers gravitating first and most to brands and products they want to buy and wear,” noted Battistini.

Against a deteriorating macro backdrop, upscale brands stand to emerge as winners. “If the consumer becomes sensitive to inflation, we would expect higher-ticket items and coveted brands in leather goods to be more protected. Consumers might also favor purchasing hard luxury items such as watches and jewelry, which potentially represent a more attractive investment,” said Battistini. This is reflected in rising Swiss watch exports, which were up 12% year-over-year in February 2023 in value terms, according to J.P. Morgan Research.

That said, luxury brands across the board will likely ramp up their marketing efforts to boost sales amid challenging market conditions. “We saw an increase in operating expenses in the second half of 2022, mostly due to higher marketing spend to maintain and further drive brand momentum,” noted Battistini. “This raises a question mark about the investments needed to excite and engage consumers, who are becoming ever more demanding.”