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Broadgate: Weekly Briefing 14/9

14 September 2012

Europe – Germany’s top court rejected calls to block the permanent eurozone rescue fund (the European Stability Mechanism (ESM)) and the European fiscal treaty, on Wednesday. European markets hit a 14 month high in reaction to the news.

But the Constitutional Court imposed conditions including a cap on Germany’s contribution, which it said could only be overruled by the German parliament.

Critics had argued that the ESM commits Germany to potentially unlimited funding of debt-ridden eurozone states. Some 37,000 people had signed a petition to the court asking it to block the ESM, and make it subject to a referendum.

U.S. – The U.S. trade deficit grew slightly in July as exports fell at a faster pace than imports.

The Commerce Department said the trade deficit widened to $42bn, 0.2% more than June’s gap of $41.9bn. However, the deficit was still lower than many analysts’ forecasts of approximately $44bn.

U.S. exports fell 1% to $183.3bn, lowered by weaker sales to eurozone nations. Imports fell 0.8% to $225.3bn, with oil imports falling 6.5%.

But imports from China hit a record $37.9bn in July, pushing the trade gap with the country to a record $29.4bn.

U.S. – Moody’s will strip the U.S. of its AAA rating if a deficit reduction deal is not agreed in Congress, it has warned.

The ratings agency made the threat ahead of the U.S. elections in November, where the national debt will be critical in negotiations and swaying votes.

Moody’s said tax increases and spending cuts, due in early January, may not be enough to prevent a downgrade and an agreement on the debt over the medium term will need to be met.

China – China’s Premier, Wen Jiabao, has told the World Economic Forum in Tianjin that his country is on track to hit growth targets for this year. He also called on international leaders to strengthen co-ordination and oppose trade protectionism during the global economic slowdown.

His address comes amid signs that China’s economy may be slowing faster than previously thought. Manufacturing and export growth have slowed, while imports have dipped.

This has raised concerns about a decline in both external and domestic demand, in turn sparking fears that Beijing may miss its growth target for 2012.

But Mr Wen said: “We are fully confident that we have the conditions and capability to overcome difficulties on the way ahead, maintain fast and stable economic growth and realise development at a higher level and with better quality.

India – Indian stocks rose to the highest level in more than six months on Wednesday, on speculation the central bank will cut interest rates next week and as German authorities cleared the way for a permanent euro-area rescue fund.

The BSE India Sensitive Index, or Sensex, increased 0.8%, the highest close since Feb. 23. The gauge climbed 4% in the previous six days, the longest streak since January.

South Korea – South Korea has unveiled a fresh stimulus plan, its second in four days, in an attempt to revive growth in its economy. Its central bank will inject 1.5tn won ($1.3bn) into banks, which will use it to provide low-interest rate loans to small businesses.

South Korea’s growth has been hurt by slowing global demand for its exports.

Exports account for almost half of South Korea’s economic output and the central bank warned the sector may remain sluggish amid economic uncertainty.

“The Committee considers the economic recovery in the U.S. to have weakened somewhat and the sluggishness of economic activities in the euro area to have deepened,” the bank said in its monetary policy statement.

Commodities – Gold climbed for a second day on Wednesday, prior to a Federal Reserve policy meeting on Thursday that may introduce more stimulus to boost the world’s largest economy.

Gold rose as much as 0.3% to $1,736.45 an ounce. Holdings in bullion-backed exchange-traded products expanded to a record 2,487.361 metric tons on Tuesday, data compiled by Bloomberg show.

Spotlight on: The insatiable demand for luxury goods

The reporting season has demonstrated the luxury goods industry’s resilience, according to Caroline Reyl, senior investment manager of the Pictet-Premium Brands fund.

On the surface, it would certainly seem like investors in premium brands should be concerned about a China slowdown. Luxury goods companies rely on Asia for 40% of their sales, with Chinese consumers accounting for around two thirds of that total. So, with China’s growth rate having recently weakened to 7.6%, its slowest pace since 2009, luxury goods companies would understandably have cause for concern.

However, looking at the majority of the earnings reports released recently, such fears look overdone for now.

Although there is evidence of a moderation in demand for luxury goods, sales growth in emerging markets eased from an average of 21% in the first quarter to 16% in the second. We believe companies in the sector remain on track to post a healthy 15%-20% rise in revenue from developing economies this year.

Indeed, we have seen resilience across many sub-sectors in the luxury goods industry. The world’s largest luxury goods company, LVMH, owner of brands such as Louis Vuitton, Moet & Chandon champagne and Tag Heuer watches, said expansion in Asia Pacific boosted sales by 13% in the second quarter, while Hermes, the most exclusive handbag maker, reported sales up 27% in the region over the same period.

Swiss watch group Swatch, meanwhile (owner of Omega and Breguet and Blancpain) said it was still seeing overall growth rates of more than 20% in China, and stood by its forecast for record worldwide annual sales of 8bn Swiss francs in 2012.

The reporting season also confirmed that luxury goods companies continue to enjoy strong earnings momentum. In 2011, margins on earnings before interest and tax stood at 22.6% for the luxury sector against 12.8% for the MSCI Consumer Discretionary segment, helped by strong pricing power and cost discipline.

This quarter, Swatch Group and PPR’s luxury division were still able to report operating margins of nearly 25%, and 20.5% for LVMH. Although the sector’s exceptional sales and margin growth of the past two years is normalising, margins for the full year look set to remain healthy.

Lust for exclusive brands

These encouraging developments in part reflect the fact that Asian consumers are not as sensitive to shifts in the economic climate as shoppers in other regions. They tend to be more selective, preferring very exclusive goods to “masstige” products (so-called mass-market prestige brands).

Another bright spot in the luxury goods earnings season was Asian consumers’ strong propensity to shop while holidaying abroad. Asian shoppers accounted for half of luxury goods sales in Europe last year, and this trend continued through into the second quarter of 2012 as tourists from the region took advantage of favourable price differentials and a strong yuan.

Long-term growth drivers

Longer term, while China will continue to be key in shaping the prospects of luxury goods companies, it will not be the only source of growth. A ramp-up of consumption from Brazil, Russia and India, the largest emerging markets after China, looks set to take place over the next decade: as duties are lowered and restrictive import regulations are relaxed, prestige brands can be expected to gain a firm foothold here too.

Whether it is luxury leather goods, fine cognacs or luxurious tourism, demand for luxury goods will remain strong throughout the emerging world for years to come. And with luxury goods stocks trading at levels equivalent to 14.6 times forward earnings, well below their historical average of 19.89 times, investors have the opportunity to capitalise on these trends at an attractive price.

The information set out herein has been obtained from various public sources and is by way of information only. Broadgate Financial can accept no liability of any sort in relation thereto and readers should obtain their own verification of any statement before making any decision which may have any financial or other impact.

Neither the information nor the opinions herein constitute, or are they to be construed as, an offer or a solicitation of an offer to buy or sell investments.

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