Wealth creation is the main driver of luxury spending, and strong economic growth leads to rising wealth especially in emerging markets. The number of affluent households is expected to double from 2010 to 2020. This bodes well for the long-term growth of the luxury industry, as there are more and more consumers who can afford buying luxury.

2011 started off well, and the outlook for the year remains promising. Top brands like LVMH and Burberry reported double-digit growth rates. All major luxury product categories and regions are doing well, except Japan.

China, the fastest growing market, shows no signs of slowdown. The tragic events in Japan which represent around ten per cent of global sales impacted sales but luxury demand is recovering faster than most expected. We expect luxury sales to advance by at least seven to ten per cent this year, driven by Asia and also by renewed strength of high-end consumption in the West.

Crazy for Western luxury brands

Many Asian consumers aspire to own Western luxury brands. They like status symbols and are not shy to show their achievements by wearing aRolex watch or carrying a Hermès bag. Consumers from emerging markets today already buy half of all luxury goods and account for the majority of growth. The Chinese are the most important luxury consumers. They rank fourth in number of millionaires, behind the US, Japan and Germany, buying nearly one quarter of all luxury products. There is so much pent-up demand for luxury that growth will be strong for several years to come.

The affection for a luxury brand can be so strong that a Chinese will spend a full month’s salary on a Louis Vuitton handbag! Even if there is a slowdown in the Chinese economy, the impact on luxury demand will most likely be limited and only short-lived as the increase in purchasing power of Chinese consumers is secular.

Prada, Ferragamo, Moncler, Jimmy Choo, Bulgari and Hermès in the M&A headlines

After their stellar performance over the last two years, luxury stocks have been attracting corporate interest, making big headlines over the last few months. LVMH took over Bulgari and a big stake in Hermès recently. Instead of doing an initial public offering, Moncler and Jimmy Choo shoes were sold to private equity firms. Samsonite, Prada and Ferragamo are all listing as publicly traded companies in Hong Kong and Milan.

Strong brands with great investment fundamentals at reasonable price

Luxury stocks are not just a quirky investment. Although valuations of listed luxury companies have rerated from their lows in 2009, they are now priced around their historical average multiples but have better fundamentals than five years ago.

Luxury companies have increased their exposure to high growth Asian consumption and have better cost controls overall. The luxury industry is growing, and strong brands are highly profitable. We expect well-managed luxury companies to outperform the broader equity market in the coming three to five years.

Pricing power protects margins

Many industries are suffering from rising cost inflation, leading to margin pressure and less profit, but luxury is affected to a lesser extent. Raw materials on average account for only ten to fifteen per cent of sales. Also, most luxury products are made in Europe and not in Asia, where wages are increasing at a double-digit pace. Thanks to luxury producers’ pricing power, cost increases can be passed on to consumers without much impact on demand. Many luxury companies have increased prices by five per cent to ten per cent already this year.

Winners and Losers

Brands that I like are Louis Vuitton, Hermès, Cartier, Omega, Tod's, Burberry, Tiffany and Estee Lauder. They are all very global and well managed. We still like watches as they also look attractively valued. We continue to like shoes of top brands as these companies have high pricing power and are less affected by global inflation and cost increases.

We have cut high-end beverages due to their greater exposure to southern Europe where consumers are suffering and also we perceive their ability to pass on higher raw-material prices to consumers, are more limited than watches and accessories brands.