The bull market is continuing to run free well into 2014 and the stock market has hit multiple new highs throughout the year. However, a sector that has beat the S&P 500 over the last 5 years has been surprisingly lagging.
Luxury stocks have stalled out over the past several months. Take a look at a comparison between the S&P 500 and the S&P Global Luxury Index (http://us.spindices.com/indices/equity/sp-global-luxury-index). In the last 5 years, the Luxury Index has posted gains of 19% versus the S&P 500’s 15.5%. Now take a look at the index over the past twelve months. The S&P 500 is up 19% while the Luxury Index has actually lost roughly 0.5%.
The big question investors are asking is: are the wealthy simply not spending as much, or are they spending it somewhere else? The answer could potentially change the way investors should be looking at the stock market. The predilections of the wealthy often have lasting effects on Wall Street.
Breaking It Down
What’s the difference between the wealthy and those who are considered middle class or poor, other than the obvious monetary answer? Spending habits.
One of the most often cited resources for determining economic growth and stability is the consumer spending index. If we take a look back over the past two years, we can see a disturbing trend when it comes to our Nation’s personal habits.
According to data taken from the Bureau of Economic Analysis (BEA), personal consumption expenditures have climbed 7.5% from $11.0306 trillion to $11.8678 trillion during that time frame while personal income only increased by 6.7% from $13.7761 trillion to $14.7032 trillion. Personal savings actually decreased nearly 20% and personal savings as a percentage of disposable income fell from 7% to 5.3%.
We’re spending more and saving less as a whole. But that doesn’t hold true across all income classes.
A study by researchers at MIT that correlated spending habits and an individual’s historical economic environment, has shown rather counter-intuitive results. It turns out that people who grew up in poorer households were more likely to spend more when faced with economic difficulties. Those who grew up in more financially advantaged households were more likely to save money.
The difference seems to do with attitudes. The wealthy tend to have a more stable and long-term outlook and therefore save up for better times whereas the more economically disadvantaged take more risks and lack a long-term financial outlook.
The study may appear to be valuable only for academic reasons, but the heart of their findings could explain why luxury items have fallen out of favor in the last year despite the growth in the overall stock market.
Does The One-Percent Know Something The Other Ninety-Nine Percent Doesn’t?
The instant reaction to why luxury stocks have declined is that the wealthy foresee upcoming economic hardship and have begun saving instead of spending. It seems like a logical answer but let’s look at the facts first.
A recent Billionaire Census taken by Wealth-X and UBS has revealed that the wealthy are holding more cash in their portfolios than ever. An average of $600 million is being held in cash by the billionaires surveyed which equates to about 19% of their net worth.
The ultra-wealthy weren’t alone according to the study. Millionaires and multimillionaires held 20% to 30% of their total assets in cash as well. The investment trend seems to be shifting to a more conservative approach with a priority on preservation even if it means zero returns rather than risk losses in equities.
That could explain the drop in luxury stock prices; Coach (COH) is down 33% YTD, Michael Kors Holdings (KORS) has fallen 7.5% YTD, and Vera Bradley (VRA) is down 3% YTD.
Although the overall handbag and leather goods market actually grew 9%, Coach’s same-store sales fell 15% for 2014 while total North American sales declined 11%. Michael Kors and Vera Bradley are experiencing similar pains which all seem to corroborate the belief that the wealthy aren’t spending in this economy.
However, the decline in luxury goods stocks doesn’t necessarily mean that the wealthy aren’t spending at all.
A survey by the Luxury Institute of around 500 wealthy individuals who had a net worth of $5 million or more detailed how the rich are spending their money. A scant 6% expected to spend more on handbags while just 4% said they were going to buy watches and jewelry. More than 80% of respondents said that luxury goods had declined in importance, signaling what could be a change in the spending habits of the wealthy.
While shopping appetites may have been curbed, others have grown. 20% of those surveyed are looking to dine out more while 33% wanted to spend more on vacations and travel. They said they were more likely to shop at mainstream retailers like Costco instead of at high-end retailers since the financial crisis in 2008. Luxury items are being looked at as frivolous expenses while the focus is shifting to entertainment and leisure instead.
It seems that spending for the wealthy hasn’t disappeared, it’s just moved locations. They aren’t preparing for an economic slowdown at all, rather they’re simply enjoying their assets in other ways.
Opportunities In The Marketplace
The wealthy could be shifting their spending habits to other sectors instead of luxury goods which creates an opportunity for investors. While the S&P 500 Global Luxury Index has lagged, the Dow Jones Leisure Goods Index has climbed around 13% in the past year.
There could be growth opportunities in restaurants, hotels, and entertainment-oriented stocks. Here are 3 stocks we found that represent value and will appreciate as the wealthy redirect their spending habits:
- Royal Caribbean Cruises (RCL)
This $15 billion cruise line company is a no-brainer for exposure to entertainment and travel stocks. The company offers vacation packages around the world from Alaska to Belize to Croatia with more than 490 global destinations. Fundamentally, the stock trades at a relatively cheap 15 times future earnings with a long term EPS growth rate of 26.5%. It pays a dividend yield of 1.6% at current prices although interested investors should be cautioned to wait for a pullback considering the stock is up nearly 45% YTD.
- Hilton Worldwide Holdings (HLT)
This company is a well-known brand in the luxury hotel space. It operates in 93 countries with over 4,200 hotel locations. This growth stock has long term EPS estimates of 27% and is committed to broadening margins and paying down debt. In the 2ndquarter of 2014, Hilton reduced debt by $250 million which brings the total reduction since it was bought out by Blackstone to $8 billion. The company is expanding more overseas with new locations in emerging markets like China which should add to shareholder value. YTD, the stock is up 11.5%.
- Chipotle Mexican Grill (CMG)
A classic growth story, Chipotle has gained around 1,400% since its IPO back in 2006. It has more than 1,600 locations across the country and growing. The stock has long term EPS growth of about 24% and has a balance sheet with absolutely zero long term debt. This makes Chipotle one of the most agile restaurants on the market with the ability to deal with adverse economic conditions. It’s up 23% YTD but still looks undervalued by around 10%.
Don’t Count Luxury Goods Out Completely
While luxury good stocks certainly haven’t had much goods news lately, there could be a reason to keep investors interested. While the upper-class of America may be changing their priorities, there’s new wealth being created overseas that could breathe new life into the luxury goods industry.
China has been experiencing a long economic boom and created a new class of citizens who can boast seven-figure bank accounts. In 2013, there were 2,378,000 millionaires in China – 82% higher than 2012 making China second only to the U.S. in terms of citizens who have a net worth of one million or more.
The sudden influx of upper-class Chinese is expected to impact the luxury goods market with more than 20% of demand coming from China by 2015. Even the middle class is getting in on the action with 12% of the World’s total demand for luxury items stemming from this group whose income averages around $35,000 USD. By 2015, there are expected to be more than 76 million households that fall into this category, further adding to the demand for these products.
Investors should keep a close eye on internationally-exposed luxury good companies and the numbers being reported from Asian markets. Stocks like Coach and Michael Kors may look like value-traps but could surprise investors in the next year or two if demand continues to increase in China.
CEO, Elite Wealth Management
Full Disclosures: http://elitewm.com/disclosures/
This article is not intended as investment advice. Elite Wealth Management or its subsidiaries may hold long or short positions in the companies mentioned through stocks, options or other securities.