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The Buy Side

When to bet on the luxury trade - and when to run away Add to ...

When markets crumble and volatility is high, many experts advise investors to “buy quality.”

Often quality is equated with purveyors of high-end goods and services. The idea is that the rich will always buy. Therefore, the theory goes, companies that cater to the affluent are insulated from the plebian worries of the mass markets, making luxury-goods merchants safer bets than most companies.

But are they? Most often, no. High end retailers and purveyors of luxury goods usually get hammered at the end of a bear cycle. It is therefore a good idea to avoid them – and even to use them as indicators for when the bear cycle is ending.

This applies not only to high-end purveyors of luxuries, but also to high-end auctioneers and to specialty retailers that sell what is not strictly necessary.

For instance, auction houses such as Sotheby's do well in a bull market, but do particularly badly at the end of a bear, because they deal in art and in expensive luxuries.

I am not against either art or luxuries, and have even been known to indulge in both. But as generators of income these two categories are highly cyclical. Auctioneers' customers are often the newly rich who made their wealth as the result of the latest economic fad. After buying the chateau and the Ferrari, these freshly minted millionaires often want to flaunt their success by buying art. Thus, as a bull market soars, so do art prices – and the price of auctioneers' stocks.

However, when an economic boom fades, auctioneers' profits not only wane, but plunge. As the bull ends, commissions tumble. Worse, by the end of the cycle auctioneers are often stuck with guarantees given to sellers, so that the final fall – when it comes – is particularly unpleasant.

We have seen this cycle before: after the junk-bond boom and after the Internet boom.

Another purveyor of luxury that goes soft when bear markets roar is Tiffany’s The jewellery retailer, however, caters to old money on a continuing basis, not just the newly rich. So while Tiffany is clawed by the market, it is not as badly mauled as Sotheby’s.

A high-end retailer that does ho-hum at the best of times is Saks Recently, Carlos Slim Helu, the Mexican billionaire, bought a bit less than 10 per cent of the company. I think he was motivated more by the desire to own an icon of affluent Americans than by the prospect of any short-term return. Before the bear market ends, Saks will be down too.

Finally, a stock I mentioned a month ago is one to avoid – Skechers . While it is not strictly speaking high-end, it is definitely a niche retailer, since no one can say that buttock-shaping sneakers are really a necessity of life. When times are tough, such purchases are often the first to be cut, as they are now.

All the above stocks, by the way, bottomed in March, 2003 and March, 2009, in sync with the previous two bear markets.

Now you may ask: which retailer is likely to do better in a better market?

I would say TJX Cos. which sells off-price apparel and home fashions, including Winners here in Canada. Even in hard times – especially then – it does okay. Indeed, its past performance, too, has been steadier, whereas the others have been far more cyclical.

It's all about timing. To give the cyclical retailers their just due, once the bear market hits bottom, stocks such as Sotheby's and Skechers can be wonderful buys, if you purchase them at the right time.

When would that be? I think Skechers, now around $16 (U.S) a share, will hit a low between $5 and $8. For Tiffany's, now around $67, I foresee a bottom between $45 and $50. Saks, now in the $9 range, will fade to between $5 and $7. Sotheby's, now around $35, should be hit hardest – to lows of $10 to $15.

Ignore the volatility in the interim. The market is taking a complicated, lengthy path to bottom here, just as it did between November, 2008, and March, 2009, or between October, 2002 and March, 2003.

Both these final bear tumbles took about six months. We are now about midway in this one, so I'd expect the final bottom between September and December.

The luxury and specialty stocks that I've mentioned above should probably reach their nadir about that time also. They would then be, as usual in market bottoms, good-to-splendid buys.

But until then I'd avoid them.

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