Luxury Retail and the New World Economy after Coronavirus

Right now, commentators are using SARS economic conditions as an allegory for COVID-19 when it’s closer to the Great Depression. The wild card to global recovery is whether we can depend on data coming out of China.

Mar 25, 2020 | By Jonathan Ho

Not very trust-affirming if the virus has indeed been “contained”

China’s President Xi has been painting. It’s a portrait of China with no new coronavirus infections. It’s a portrait of China as a sanctuary and model of coronavirus containment, even as cases of Covid-19 soar across the US and Europe with a close to 400,000 infected and 17,000 deaths. It’s a painting occasionally punctuated with the odd optic of President Xi Jinping “visiting” Wuhan, ground zero of the Covid-19 outbreak, via video conferencing (prudence!) and then the contrarian declaration that “the virus has been contained” across Hubei province.

But there are two Chinas – one perspective of the Middle Kingdom that scared provincial officials want to paint for the CCP party organs and the other is a perspective of China that Xi himself wants to  project – which doesn’t necessarily mean the best picture all the time: sometimes he wants transparency (depending on what his realpolitik objectives are); but the fear at the lower levels is too great and so everything is usually distorted. Add diplomats and ministers who have their own personal agendas for career advancement and you’ll discover that China’s operating environment is more complex than anything else on earth.

China Has Two Faces: Why projections of the New World Economy after the Coronavirus outbreak will be problematic

Beijing-based Caixin, an independent magazine covering socio-political, and economic issues in the mainland, broke news of a troubling new development: that local companies and officials wee fraudulently boosting electricity consumption and other metrics in order to meet tough new back-to-work targets in support of Xi’s “coronavirus contained” narrative.

Under pressure from provincial officials and civil servants, the companies created the appearance of economic activity by leaving lights on, air-conditioners and production lines running up in order to drive up electricity consumption (a proxy data-set for resumption); even going so far as to coax employees and workers on what to say to inspectors, giving the local authorities nice statistics to send back to Beijing.  In fact, on Feb. 24, Zhejiang Provincial Government Deputy Secretary-General Chen Guangsheng announced to press that its work resumption rate was more than 90% and that “more than 99% of the coastal province’s companies with annual export value above $10 million had resumed business”. But here’s the thing – logistics, supply chains and traffic don’t lie: traffic is still at all time lows and companies still lack access to their secondary goods.

In December 2019, Zhao Lijian was christened by Buzzfeed as “the world’s most interesting diplomat”. Combative, Zhao, a career civil servant, official job title: Spokesperson & Deputy Director General, Information Department, Foreign Ministry. is at best described as an “internet troll” at worst, “the Trumpian voice of the CCP”. Indeed, Zhao pulls no punches and minces no words as he tweets @DonaldTrump on everything from human rights abuses and with the coronavirus outbreak, his bungled handling of the situation and even his “replacement anxiety” as his leadership continues to cede US dominance on the world stage (since been deleted). Witness a sample of Zhao’s masterful troll tweet:

The 31st spokesperson since the position was established in the ministry back in 1983, 48 year old Masters graduate Zhao has perfect command of English, charting a stratospheric career through the ministry with his extremely public and uncharacteristically social use of Twitter to directly confront critics of the Chinese government. That said, his latest tweetstorm involving coronavirus conspiracies has forced the Chinese Foreign Ministry to distance itself from its own spokesperson.

“Eventually, we must have an answer to where the virus originally came from. But this is the job for the scientists to do, not for diplomats.” – Cui Tiankai 崔天凯, Chinese Ambassador to the United States

According to Chinese ambassador to the US Cui Tiankai,  崔 avoided criticising Zhao directly during an interview on HBO’s Axios program by re-affirming his February 9th statement that, “there are people saying that the virus is coming from some military lab in the United States. How can we believe these crazy things?” He added that it should be left to scientists to investigate where the virus originated and that it was “very harmful” for diplomats (Zhao is a diplomat) to speculate. When pressed, “Does he [Zhao] speak for the Chinese government, or do you?” Cui (崔) responded: “I am the representative of China in the United States.” Cui outranks Zhao by at least two levels.

Chinese Ambassador to the US, Cui Tiankai speaking on HBO’s Axios

Therein lies the problem, in the new world heralded by the coronavirus outbreak, it has become exceedingly difficult to gauge business and consumer sentiment when a country and even its leadership apparatus has limited control (or even predictability) over how its lower echelons and executors react to CCP directives. Recall Dr Li Wenliang, the doctor censored and censured for trying to warn colleagues about the outbreak as early as December 2019, where he was arrested by the police for disrupting social order and accused of “rumour-mongering” where local officials either ignored or played down the risks well into January, prompting another rare departure for Beijing’s judiciary: The Supreme People’s Court’s rebuke of Wuhan police for reprimanding eight Wuhan citizens for “spreading rumours” about an illness stating, “It might have been a fortunate thing if the public had believed the ‘rumors’ then and started to wear masks and carry out sanitization measures, and avoid the wild animal market.”

“This has certainly been a fragile time in the psyche of Chinese consumers with all the fear and anxieties caused by uncertainty and information overflow,” – Derek Deng, partner with Bain & Company in Shanghai

People wearing masks are seen at a shopping area in Shanghai, China, as the country is hit by an outbreak of a new coronavirus, February 4, 2020. REUTERS/Aly Song – RC2LTE9PSN4F

Luxury Retail and the New World Economy after Coronavirus

According to Bain & Company, post-epidemic consumption recovery will “largely follow patterns similar” to the 2002-2003 SARS outbreak. Derek Deng, Bain & Co. partner projected that, “Consumer sentiment is still in the process of returning from panic to normal or a new normal.” Indeed, Birkin handbag maker Hermes re-opened 39 of its 43 mainland China stores late last month but Hermes CEO Axel Dumas was reported in CNBC saying that despite shops reopening, store traffic in greater China, where consumers account for a third of the luxury goods industry’s customers, had yet to recover from the fallout of the coronavirus outbreak.

Having developed a reputation for being particularly resistant to downturns, Hermes has long been regarded as a bellwether indicator for consumer sentiment but its telling that maker of one of the world’s most appreciable alternative investment grade assets has found it difficult to estimate the impact of the disease on group sales. Like most luxury brands, Hermes makes over 30% of its revenues from the Asia-Pacific region, excluding Japan.

Hermes re-opened 39 out of 43 of its stores late February but foot traffic has yet to return

Deng said that after SARS, demand for luxury goods and clothing surged beyond pre-epidemic levels once food & beverage consumption returned to normal but the luxury industry wasn’t as exposed to China during the early 2000s.

“The coronavirus pandemic has begun to affect consumers’ views of their own financial situation and confidence in spending, a key difference from recent periods of depressed consumer confidence,” – Morning Consult economic intelligence unit

When President Donald Trump announced that the United States was suspending travel from Europe to the U.S., consumer confidence experienced its largest single-day drop in over two years. According to the Morning Consult’s Economic Intelligence Unit, the coronavirus pandemic has begun to affect consumers’ views of their own financial situation and confidence in spending, a key difference from recent periods of depressed consumer confidence. 

It must be stated unequivocally: the United States was the top ranked personal luxury goods market with an estimated market value of about 75 billion euros in 2019. What’s particularly troubling of the Morning Consult’s data-set, was that consumers at all income levels were feeling less confident, even high income Americans who were usually inured (by way of significant holdings and sufficiently diversified portfolios) saw their confidence levels evaporate the fastest and dropping the furthest; showing that highly discretionary business segments like the luxury market (of which Hermes is a key participant) were going to be among the hardest hit businesses in the coming months. Furthermore, high income workers account for a disproportionate percentage of total U.S. consumer spending so their views of the economy drive most of the fluctuations in total spending.

According to an ad-hoc survey conducted in February by Italian luxury brand consortium Altagamma, in association with Boston Consulting Group and investment firm Bernstein, luxury brand CEOs and CFOs are also bracing for a decrease in sales between €30 and €40 billion, bringing the value of the personal luxury market to between €309 and €319 billion, its lowest point since 2015.

Over the last two decades, China has become both producer and consumer: Today, Chinese consumers account for a third of global luxury consumption, East-Asia has a whole accounts for about 35% of the  global luxury market with the spread worsening in the largest luxury market – US, and the birthplace of luxury – Europe, BCG-Altagamma project that effects of the virus are going to extend beyond the first half of 2020 into 2021, pushing sales of global personal luxury back to levels not seen since 2015.

It’s a sentiment further reflected in cessation of advertising spend as product launches are shelved and brand events are cancelled. Even if brands like watchmakers Patek Philippe and Bvlgari are not as exposed in China as some of their other high horology counterparts who embraced the Chinese gold-rush headlong, they are nevertheless still exposed to a not insignificant degree. Luxury conglomerate LVMH derived 37% of its €53.7 billion total revenues in the region, rival Richemont Group was greater exposed at 38%, Salvatore Ferragamo (38%), Versace (36%), Jimmy Choo (29%) and masstige brand –  Michael Kors (12%). According to Thomas J Edwards, Jr., executive vice president, CFO and COO of Capri Holdings, owner of the latter three brands, China makes up for more than half of the company’s business in Asia.

WUHAN, CHINA – FEBRUARY 01: (CHINA OUT) An expressman drives down an empty street as he delivers packages on a bicycle on February 1, 2020 in Wuhan, Hubei province, China. The number of those who have died from the Wuhan coronavirus, known as 2019-nCoV, in China climbed to 259 and cases have been reported in other countries including the United States, Canada, Australia, Japan, South Korea, India, the United Kingdom, Germany, France, and several others. (Photo by Stringer/Getty Images)

Post 2002-2003 SARS outbreak, spending on food and cosmetics saw a quick return to normal but CNBC reported comments from Gao Huan, a senior director focused on retail and manufacturing at consulting firm Alvarez & Marsal in Beijing noted that, “The return of (the) labour force is definitely a key factor why the recovery rate is so low for the recovery of the restaurant business.” 

“For the poorest households in the country, the number of migrant workers who had returned to their jobs as of Mar. 5 was 52% of what it was last year, at 14.2 million” – Su Guoxia, spokeswoman of the State Council’s Poverty Alleviation Office

Xin Guobin, Deputy Head of Ministry of Industry and Information Technology

Beijing’s municipal government social distancing guidelines mean that the restaurants are only allowed to seat two or three people together but the real issue is that workers who typically frequent these outlets haven’t exactly returned to work either. According to China’s Ministry of Industry and Information Technology, state-owned companies and large industrial businesses have officially resumed work at a rate of around 90% or higher but small and medium-sized enterprises outside the virus’ epicenter of Hubei province have only resumed work at a rate of about 60%. Xin Guobin, the ministry’s deputy head told reporters, “Travel restrictions and mandatory quarantines have made it difficult for many people to get back to work. Businesses still face problems such as the inability of people returning to work, as well as stalled logistics operations.” Furthermore, even if consumers return, the food & beverage businesses themselves have a labour force problem: the services sector hires many people from less developed parts of China and they have issues getting back to work as well.

And therein lies the quandary, how much of Xin’s information is reflective of actual conditions as opposed to information and statistics that have been “massaged” by lower level officials before they reached him.

The Right Analogy for Covid-19 is The Great Depression not SARS

Right now, a lot of commentators are projecting a recovery similar to the one experienced post-SARS but the global nature of the coronavirus outbreak is an epidemic beyond 2003’s SARS that affected “only” more than two dozen countries and infected 8000. This virus war is global, almost every country is affected. The economic conditions we are experiencing now are closer to the Great Depression than SARS. Then (the 1920s) as in now the US stock market underwent a historic expansion. In 2010, the Dow Jones Industrial Average closed at 10,700 points; by 2019, the stock market close to tripled, by early 2020, the average closing price was 26,960.

Right now, we are not just fighting a war against the virus but also the profound psychological shock and loss of confidence in the economy among both consumers and businesses, a primary precipitator of the Great Depression. It became a self-fulfilling prophecy as, consumer spending and business investment were drastically reduced, leading to immense falls in industrial output and job losses, which further reduced spending and investment, eventually leading to bank runs, subsequent panic and monetary contraction. We need to treat the economy as if we were headed for another Great Depression and not think like it is going to be what it was during SARS. Thankfully, the lessons learnt from that last event has prompted early action from Central and Reserve banks around the world with significant quantitative easing and cash injections into national economies. That said, the luxury segment of retail is heavily dependent on consumer psychology.

The Duomo Square in Milan after the Italian government imposed a lockdown on in north due to the coronavirus

The Bright Side: Luxury consumption is heavily dependent on consumer psychology

Luxury consumer spending is an exercise of emotions rather than rational decision making. Amidst national lockdowns and closed transnational borders, consumers are experiencing more anxiety and a profound sense of insecurity as evidenced by Morning Consult’s data-sets. During the 2008 Great Recession, the affluent merely took a small hit to financial security, but with the string of two black market events, the spectre of global economic crisis and a marauding virus that has a mortality rate of 3.5% and rates of 7.8% in countries like Italy, claiming the lives of close to 19,000, the threat is also to their physical wellbeing.

This anxiety to both health and home is unprecedented and as a result, the sense of insecurity is very similar to conditions during the Great Depression rather than the comparatively recent global financial crisis or SARS. However, as hindsight will show: economic recovery post-Depression and Post-World War 2 brought us the golden age of capitalism.

A symbol of post World War 2 prosperity – almost everyone had a car

The Long Boom was a period of great economic expansion which lasted for 20 years. As life gets better after a period of emotional crisis, the rebound spending or “revenge spending” results from a strong emotional impetus to re-affirm one’s self-identity and self-worth – the very qualities which luxury brands seek to cultivate and reinforce.

“Luxury says to the world that I’m doing well and that I can afford this. From that comes a greater sense of comfort and security. The spending that comes after hard times is more about identity and security.” – Chris Gray, Psy.D., founder of consumer psychology consultancy Buycology

Revenge shopping in China at Plaza 66’s Chanel boutique as luxury consumption slowly returns

Revenge Spending: Chinese luxury industry showing signs of recovery

“We see a slow improvement in the business in China,” said Salvatore Ferragamo SpA Chief Executive Officer Micaela Le Divelec Lemmi.  “On top of the traffic, the mood of the Chinese customers will also be relevant. After a month and a half of closures and restrictions, there is a will to come back and have a real life.” Speaking to Bloomberg, Andy Li, employed in Fintech, echoes Lemmi’s sentiment: “I was trapped in my home for an entire month. Our residential compound was chained up, and we were not allowed to go anywhere. Now I feel somewhat free again.”

In fact,  Chris Gray, Psy.D., founder of consumer psychology consultancy Buycology and an early pioneer in the shopper psychology field with advertising agency Saatchi & Saatchi, told Pamela N. Danziger, Forbes Senior Contributor that, “Showing your identity is a very important emotional aspiration that plays into shopping behaviour. Luxury says to the world that I’m doing well and that I can afford this. From that comes a greater sense of comfort and security. The spending that comes after hard times is more about identity and security.” Gray also foresees luxury brands could get a boost after this crisis.

That said, while the number of officially confirmed new cases in China has slowed, there’s a risk that infections could rise again now that more people are resuming activities and inbound travellers or returning residents could spark new outbreaks by bringing the virus back to China from abroad as in the case of Singapore.

Returning residents passing Changi International Airport’s Jewel extension

Two days ago, Singapore, the 7th largest luxury watch market in the world, reported 54 new COVID-19 cases, its highest most recent daily spike, which included 48 imported infections. The imported cases had travel history to Europe, North America and ASEAN countries. All except one were returning residents and Long Term expatriate workers, according to the country’s Ministry of Health. With the total of 509 cases, the complexity with the imported cases is that 9 out of 10 of them were not detected on arrival at Changi International Airport as they did not show symptoms.

The cases were detected only later during the three-day period when they saw a doctor after they returned home and there have been mounting concerns that people with coronavirus may not show typical symptoms like fever (detectable at checkpoints by thermal scanner), dry cough and shortness of breath. Citing classified data from the Chinese government, the South China Morning Post reported on Sunday 22 March that as many as one-third of the people who test positive show delayed symptoms or none at all.

According to a Harvard study, Singapore is held as the “gold standard for case detection”. The world is detecting imported cases of Covid-19 at 38 per cent of Singapore’s ability to do so, said four epidemiologists from the Harvard T. H. Chan School of Public Health in the study. The pre-print report, which was uploaded on online medical archive medRxiv, looked at aggregated data of imported cases as of Feb 4 from the World Health Organization (WHO), taking into account 191 territories around the world.

Unlike Singapore’s stellar transparency and information dissemination, China’s track record has been found wanting: from the initial cover-up of the coronavirus outbreak to the subsequent suppression of information about the virus, resulting in little containment and unchecked spread in the crucial early days and weeks, imperilled not only its own country and but the more than 100 nations now facing own devastating outbreaks.

“The precision of the Chinese numbers is rightly questionable, (but) I think the direction is probably accurate. I’m sure there are still undiagnosed cases, and probably even undiagnosed fatalities,” said Scott Clemons, chief investment strategist for Brown Brothers Harriman in New York. Indeed, with Europe now surpassing China in the number of infections, and mortality rates, and Hubei province data no longer fully trusted, there are many uncertain projections, especially with investors are looking at how Europe and the US will fare with forced quarantine measures, especially if Chinese data ends up a “false negative”.

One can only hope that with the Chinese Ambassador to the US’s recent candour on HBO (however indirectly addressing his colleague Zhao Lijian’s attempts to troll the world), means that President Xi and the Chinese Communist Party are open to a kind of honesty that isn’t about “saving face” and assigning blame, however, the sad reality is that at the ground-level, the party organs and local authorities haven’t exactly been conditioned for truth (case in point: Look what happened to Dr. Li Wenliang).

Editor’s Note: Foreign Ministry Spokesman Zhao Lijian posted this after the Ambassador distanced the Ministry from his comments)

 


 
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