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Equity Perspectives

Luxe may draw big bucks, but slower economic growth has taken its toll. Lord Abbett analysts Sue Kim and Lovey Morse examine the trends and opportunities.

As research analysts covering the consumer discretionary sector, Lovey Morse and Sue Kim spend countless hours on the road visiting managements, poring over outside research data, and checking stores to see what’s “hot,” what’s not, and why. And when it comes to evaluating the investment prospects of publicly traded luxury companies, part of the process takes them to Paris, where couture and commerce intersect in spectacular fashion.

Lately, however, the market for luxury items such as $18,000 watches, $4,000 ladies’ handbags, and $700 men’s shoes, among others, has collided with low growth and economic uncertainty, all of which underscores the need for experienced research and active management capable of spotting attractive stocks and avoiding others.

After meeting with top management of various companies while attending the recent HSBC Luxury Conference in Paris, Morse and Kim gained greater insight into the industry’s slowdown. “The era of 5–8% market growth is over (see Chart 1), and companies now are designing new strategies to accommodate for more modest gains of 1–2%,” said Morse, who has been covering the luxury and retail sectors for 16 years, and works on the International Small Cap strategy. “Industry forecasts were recently downgraded from mid-single-digit growth several months ago. One high-profile CFO told me that he is expecting flat market growth in the next two years, which is more cautious than others have told me.”


Chart 1. Currency Fluctuations Inflated the Luxury Goods Market, While Real Growth Slowed

Source: Bain & Company, as of December 21, 2015.


U.S. Is Not Supportive
How’s this for a study in economic contrasts: The United States represents 24% of luxury spending, while China now accounts for 31%, according to Bain & Company. The number-one reason why Chinese travel is to shop, said Morse, adding that pricing can still vary more than 60% across geographic areas, so the value of currencies will dictate travel plans. 

“With the slowdown in China, the U.S. market had provided support to the sector, while other countries suffered,” said Morse. “However, the overall sector is experiencing much volatility as evidenced by a significant downturn in first quarter 2016 after an improvement in fourth quarter 2015 and a slowdown in the third quarter. The slowdown was a surprise to the luxury management teams, and excess inventory exists.”

The cause of such volatility has generated much confusion. Poor weather would have played a role. However, there were few interesting fashion trends at a time when dollar strength would have hurt, Morse added. Furthermore, consumers are putting their money toward experiences away from products. The dollar moved to €1.12 in the first quarter, compared with last year, at closer to €1.20 (according to Bloomberg), which would have the impact of making the United States a less-appealing tourist destination compared with other countries.

While department stores continue to carry excess inventory, which is expected to continue through the second quarter, Morse believes luxury brands need to do a better job controlling their wholesale exposure and building in-house retail capability to better preserve long-term brand equity. Despite a pullback after the global financial crisis of 2008–09, many brands expanded into U.S. department stores, but now are looking to reduce their reliance on that channel. As a result of that over-dependence on department stores, outlet stores have been jammed with excess inventory. 

New Strategies for Growth
As companies decrease their reliance on U.S. department stores, they seek to increase their own retail and online exposure. “New strategies designed to drive future growth in the luxury sector include ‘Retail Excellence,’ a new buzzword for pushing assets harder to improve the customer experience, both in stores and online,” said Morse.

Every executive Morse met with spoke about spoke about improving sales/square foot, and how to translate the store experience to online. However, she believes some strategies are better poised to reap benefits than others. This will be urgent in the face of slower space expansion, and the growth of pure-play online retailers. Mobile transactions dominate purchases with millennials, yet social media engagement is weak at most companies.

“All companies are putting money into driving customer engagement, but the industry has been very slow to embrace an online presence,” Morse said. On that note, in one of her discussions, a high profile CFO noted his company is unprepared for millennials, because the company just doesn’t understand that demographic. Yet, online shopping is believed to be one of the largest disruptions of the luxury good industry since the birth of department stores in the nineteenth century.”1

Lack of Pricing Power and Limited Growth Potential
After attending the HSBC Luxury Conference in Paris, where she met with representatives of more than 20 companies, Sue Kim didn’t mince words. “The luxury companies got too greedy during the recent emerging market consumer boom. They over-earned by excessively pushing up product prices and flooding the market with too many stores and products. And now they have lost pricing power and image of scarcity, the very factors that define luxury,” said Kim, who covers large-cap luxury companies.

To illustrate her point on how far product prices have escalated, Kim noted that the same exact Chanel bag that retailed at below $3,000 in 2010 was selling for nearly $5,000 by 2014. Furthermore, most luxury goods cost even more in China than in Europe and the United States, beyond what can be explained by extra import duty and value added taxes. 

According to Kim, what exacerbates the current pricing dilemma is the confluence of numerous headwinds, such as China’s new tax scheme aimed at stimulating domestic consumption, slower economic growth, increased foreign-exchange rate volatility, geopolitical risks that have dampened tourism, increased price transparency due to the Internet, and the millennials who prioritize experiential consumption over material goods.

Between slower economic growth and greater price discovery over the Internet, luxury companies have had to cut prices, using various euphemisms. “The phrases du jour were ‘product repositioning,’ ‘rebalancing price architecture through new collections,’ and ‘enriching or refreshing entry-level product line-up.’”

“Many have cost-cutting initiatives to avoid operating de-leverage,” Kim continued, “but of course these cost-cutting initiatives [e.g., exiting unprofitable stores, reducing headcounts] usually come at additional upfront costs for the first couple of years.”

What Are the Bright Spots?
For all the headwinds facing the luxury-goods sector, Kim noted that with most companies not adding stores, sector cash flow is likely to remain steady. Meanwhile, select smaller, nimbler players that didn’t have sufficient capital to build hundreds of stores during the boom, especially in emerging markets, should generate stronger sales growth from store network growth and better pricing power.

Also, “the more affordable the better,” Kim said. “Given all the pricing issues we’ve discussed, it’s not a coincidence that one luxury brand that’s strongly outperforming offers its iconic bags at significantly lower price points than those of its peers. Nor is it a coincidence that one seller of affordable jewelry is doing exceptionally well. Even within one of the best-known luxury brands, the cheaper products are doing very well.”

Could upstart innovators, savvy about digital marketing, further disrupt the existing order of the luxury-goods business? Not yet—so far their impact has been minimal. But the prospects of disruptive change could be significant, given the vulnerability of established luxury companies that have pushed prices too high in the past several years.

“There have been numerous new entrants in the market to fill that gap,” Kim said. “They are often pure-play online retailers and are very savvy in digital marketing, offer high quality for money, and connect well with millennial consumers through value propositions such as personalization, simple luxury, andsustainable manufacturing.” 


1 John Seabrook, “The Geek of Chic,” The New Yorker, September 10, 2012.

The information and examples provided are for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice.

Investing involves risk, including possible loss of principal. The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy.

Forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.

The opinions in the preceding commentary are as of the date of publication and subject to change based on subsequent developments and may not reflect the views of the firm as a whole. This material is not intended to be legal or tax advice and is not to be relied upon as a forecast, or research or investment advice regarding a particular investment or the markets in general, nor is it intended to predict or depict performance of any investment. Investors should not assume that investments in the securities and/or sectors described were or will be profitable. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy or completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.


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