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MacroResearch Board
I n d e p e n d e n t I n v e s t m e n t S t r a t e g y
The wealthy have captured a greater share of economic prosperity
away from wage earners and back to capital owners,
triggering the start of what would be a prolonged trend
towards greater income inequality1 (chart 2). Indeed,
profits and incomes of capital/business owners and
senior executives have powered forward over the past
three decades, even as laborers in many countries have
seen only minimal real income growth despite higher
productivity (chart 3).
In short, the early-1980s marked the beginning of a
structural shift in the distribution of income towards
greater inequality. Changes in policies and other macro
factors allowed the wealth creation to be absorbed by a
smaller segment of the global population. This provided
fertile ground for a sustained rise in the demand for
luxury goods and services.
Emerging Asia Industrialization Amplified The Trend
The industrialization of emerging Asia (and other manufacturing-based EM economies,
including Mexico) since the early 2000s amplified many of the trends started by Reagan
and Thatcher. Lower labor costs, rapid productivity gains, and free trade agreements
(including the formation of NAFTA in 1994 and the WTO in 1995, which China became
a member of in 2001), enabled emerging markets to become major providers of 1 The Gini coefficient is a commonly used measure of income equality, which ranges from 0 to 1. Zero
implies that everyone has the same income, while 1 implies that a single individual earns all the income of the economy. It is named after the Italian statistician, Corrado Gini, who first created it in 1912.
Chart 3 Global Capital Owners Have Thrived
20
25
Global:Exports* (% of GDP)
200
400Real Profits**
70
90
Real Unit Labor Costs***
5
10
1980 1985 1990 1995 2000 2005 2010
Core CPI Inflation**** (%YoY)
* Source: OECD** Deflated by core CPI; rebased to January 1980 = 100; source: Datastream*** Deflated by core CPI; rebased to January 1980 = 100; source: OECD**** Excluding food and energy; source: OECD
The number of wealthy people and their net worth has mushroomed
manufactured goods. In turn, globalization surged (as
measured by global exports/GDP) and reinforced the
disinflationary tailwind by putting downward pressure
on tradable goods and services prices (chart 3). Also,
increased global competition and the ability to offshore
production acted as a drag on OECD manufacturing
sector wages and further drove down unit labor costs
across the globe. These forces led to greater aggregate
economic prosperity and lower interest rates.
At the same time, the industrialization of emerging Asia
led to a dramatic increase in global commodity demand,
fueling growth in natural resource-based economies
(many of which are also in the emerging world). Unlike
during the OPEC embargo of the 1970s, higher commodity
prices were primarily driven by stronger demand and not
by reduced supply. In turn, while there has been some crowding out, commodity prices
are a reflection of greater productivity, increased efficiencies and stronger global growth
(rather than act to strangle the latter). Thus, commodity exporters have benefited over
the past decade from both higher export prices and output volumes, increasing their
overall wealth and creating positive multiplier effects within their economies.
Importantly, the windfall experienced in the emerging world have contributed to sizable
global economic gains, rather than merely transferred wealth away from the developed
world. Net gains are typical during industrialization phases, due to the dramatic boost in
productivity. The emerging world has unquestionably obtained a greater proportion of
global growth, but the developed economies also expanded at a healthy clip (at least up
until the Great Recession). Disinflation and lower interest rates fueled housing/financial
wealth gains and a consumption boom. While many advanced nations overreached and
are now forced to work through their imbalances, the number of ultra-wealthy people
and the total assets they hold has mushroomed since the 2000s (chart 4).
The maps on the following page emphasize the wealth creation over the past decade.
The circles that represent the countries in both maps are proportionate to the total net
worth of billionaires in 2013. Clearly, this segment of the population has become much
wealthier across the whole world over the past 10 years. Also, there has been a dramatic
increase in the percentage of wealth that is now located in emerging markets (which
we colored in green for convenience). Statistics for each country are provided in the
appendix table A1 on page 17.
In short, emerging Asian industrialization has been critical in driving the demand for luxury
goods and services, by broadening the market beyond just the advanced economies. The
Emerging Asian industrialization and the corresponding commodity boom have created tremendous wealth... ...broadening the market for luxury beyond the advanced economies
have significantly outperformed the average of past
recovery phases, benefiting capital owners and senior
management. This has also triggered a strong bull market
in global equity prices, while the disinflationary tailwind
has kept bond yields low (at least until recently). In turn,
high net worth individuals have disproportionately benefited from financial asset gains.
In contrast, labor has not participated equitably from the economic gains. U.S. and G7
unemployment rates surged during the Great Recession to levels well above equilibrium
and have been slow to decline, as job creation has trailed historical norms (chart 6). This
has removed the bargaining power of labor and allowed companies to maintain wide profit
margins. Chart 7 from the December 3 MRB Theme Report3 shows the key components of
profit margins for the U.S. nonfinancial sector: unit labor costs, unit non-labor costs and
selling prices. Profits relative to GDP have exceeded previous cycles, even though selling
prices have been far weaker than in the past. The reason is that companies have had
remarkable success in driving down labor and non-labor costs per unit of output. While these
charts use the U.S. as an example, the same phenomena can be observed across the globe.2 The tendency for “elites” in emerging economies to replicate the consumption patterns of their peers in
the developed world is well documented in economic development literature.3 MRB Theme Report, "U.S. Profit Margins: Still Too Soon To Worry", December 3, 2013
The recovery since the Great Recession has reinforced the pre-existing patterns of income and wealth inequality
Chart 6 U.S. Job Market Recovery Has Been Much Slower This Cycle
June 2009Average Of Past 8 Cycles(all panels)
100
108
U.S.:Employment*
2006 2008 2010 2012 2014
6
8
Unemployment Rate** (%)
* Total nonfarm payrolls; source: U.S. Bureau of Labor Statistics** Source: U.S. Bureau of Labor StatisticsNote: Panel 1 rebased to 100 at NBER-designated U.S. recession troughsas denoted by the vertical line
Chart 7 U.S.: Selling Prices And Input Costs Have Been Weaker Than The Norm
80
120
160
Current CycleAverage Of Past 8 Cycles**(all panels)
U.S. Nonfinancial Sector*:Per Unit Profit
80
100
Unit Price
80
100
Unit Labor Cost
2002 2004 2006 2008 2010 2012 2014
80
100
Unit Non-Labor Cost
* Rebased to Q2 2009 = 100; source: U.S. Bureau of Economic Analysis** Average boom/bust cycle aligned with the troughs of per unit profits as denoted by the vertical line
* Equally-weighted aggregate of brent oil & copper; rebased to January 1998 = 100** Captures impact of liquidity and currency; derived from CRB precious metals index*** Captures economic growth and final demand versus supply
highly correlated with affluence, arguably the trend has
been accentuated by the amount of “new money” that
has been created. Generational wealth typically already
has or inherits many luxury items, but new money needs
to build their lifestyles from scratch. Also, many use
luxury items as “positional goods” to identify their newly
established “place” in society5.
Media programs about the lifestyles of the rich and
famous (which were novel a few years ago) have now
become commonplace. Also, articles of luxury have
become so popular (including the FT’s “How To Spend
It”) that Bloomberg recently added a new section
devoted to the subject. These are often contrarian
warnings that a long-term structural theme has become
overdone or is nearing an end. Thus, it is appropriate to stand back and assess whether
the luxury theme has moved ahead of the improvement in underlying fundamentals.
Unfortunately, many of these items lack historical price series. Nonetheless, we have
compiled a few examples to analyze from both the unlisted and listed sectors.
Unlisted Sector
m Valuables Index: The Economist magazine publishes a Valuables Index, which includes
art, classic cars, coins, guitars, stamps, violins and wine (chart 10). The aggregate index
has more than tripled over the past decade. After rising dramatically from 2003-2008,
the Valuables Index then corrected briefly, before surging to new extremes and still
continues to move higher.
m Super Cars: Classic automobiles have been the strongest component of The Economist
Valuables Index, with prices jumping more than 6 times over the past decade. In fact,
the Historic Automobile Group International (HAGI) Top Price Index of rare collector
automobiles jumped 47% in 2013 alone6. Articles about new all-time highs in prices at
vintage car auctions seem to be a regular occurrence. For example, a 1963 Ferrari 250
GTO racer smashed all previous records last year, selling for a whopping $52 million.
While obviously an extreme, there is a large and increasing number of cars selling at
auctions for seven and eight figure price tags.
There is also no shortage of stories about new super cars that try to outdo each other on
top speed, acceleration, comfort and/or customizability. Those cars, plus the luxury 5 A positional good (a term coined by Fred Hirsch in 1976) is a product or service whose value is at least
in part (if not exclusively) a function of its ranking in desirability by others. The extent to which a good's value depends on such a ranking is referred to as its positionality.
6 HAGI Top Price Index is designed to measure rare collector automobiles, ranging from pre-war to the new millennium.
The price of global luxury items has gapped higher... ...as the rich get richer and "new money" attempts to build their lifestyles
Chart 13 Prime Global Property Prices Have Moved Parabolic
Prime London**LondonEngland And Wales
100
140
180
House Prices*:
2002 2004 2006 2008 2010 2012 2014
Residential*** (LS)Commercial**** (RS)
100 –
200 –
300 –
200–
400–
Hong Kong Property Prices:
* Rebased to January 2004 = 100; source: U.K. Land Registry** Average of four most expensive boroughs in London*** Hong Kong Island only; 3-month moving average; rebased to January 2004 = 100; source: Rating and Valuation Department, Hong Kong**** Rebased to January 2004 = 100; source: Central Statistics Department, Hong Kong
have rallied more than 500% from their 2009 lows. Indeed, a bidding frenzy has now
developed for these stocks8.
The dramatic price appreciation in these equity indexes is in part reflective of the powerful
increase in sales and profits of the underlying firms. However, market forecasts of future
revenues and earnings of luxury companies over the next couple of years extrapolate
the parabolic upleg (chart 15). This leaves substantial room for disappointment. Even
accounting for these overly optimistic projections, valuations have become rich, with
forward P/E ratios trading at a 27% premium to the broad market (chart 16). Price/book
ratios are even more stretched, with global luxury stocks currently trading at a 60%
premium over the broad market. Thus, anything that even slows the pace of increase 8 Moncler, the luxury skiwear maker, was the most successful European IPO of 2013, pushing the market
capitalization up nearly 50% to €3.7 billion after receiving €20 billion in orders.
Investors are overly upbeat on luxury firms and likely to be disappointed
The information, recommendations and other materials presented in this document are provided for information purposes only and should not be considered as an offer or solicitation to sell or buy securities or other financial instruments or products, nor to constitute any advice or recommendation with respect to such securities or financial instruments or products. This document is produced for general circulation and as such represents the general views of MRB Partners Inc., and does not constitute recommendations or advice for any specific person or entity receiving it.
This document is the property of MRB Partners Inc. and should not be circulated without the express authorization of MRB Partners Inc. Any use of graphs, text or other material from this report by the recipient must acknowledge MRB Partners Inc. as the source and requires advance authorization.
MRB Partners Inc. relies on a variety of data providers for economic and financial market information. The data used in this report are judged to be reliable, but MRB Partners Inc. cannot be held accountable for the accuracy of data used herein.
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