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Mr. Marx, You Cannot Afford This Saddle

Over the past two centuries, we have become a far more prosperous society than any other in history. Looking at Graph 1, we can see that the percentage of the globe living in extreme poverty has declined from 76% in 1820 to 8% in 2022. Although we have lifted ourselves out of poverty, we have become increasingly unequal. We live in a society where the scales tilt largely unfettered by socialist checks and balances, in favour of the wealthy. This phenomenon has caused interesting externalities in the stock market and alternative asset prices.

Has it always been this way? The short answer is yes. Historians Will and Ariel Durant, authors of the 11-volume "Story of Civilization," show that over thousands of years of civilization, from the ancient empire of Solon’s Athens to the age of North American hegemony, resources have accrued to the cleverest and most talented of our species, causing large inequalities. These wealth distortions then rupture either through peaceful partial redistribution, as was the case in Solon’s Athens, or through violent revolution at the point of a sword, like Rome half a millennium after Solon or the French Revolution. After the partial redistribution, wealth starts to be concentrated over time in the next intelligent and powerful elite.

Recently, the path to inequality has been paved with lowering marginal tax rates and safeguarding tax loopholes that hinder wealth redistribution. In the 1940s to 1960s, the marginal tax rate on the wealthiest US citizens was consistently above 80%, averaging around 90%, before dropping to 70% in the late 1960s and 1970s, and then to under 40% in the late 1980s, where it remains for those who can't avoid it through the loopholes that we all got to know through the Panama and Pandora Papers' data dumps. If we look at the US, the world economic hegemon, we can see in Graph 2 that upper-income households went from earning 29% of US aggregate income in 1970 to earning 48% in 2018, while they went from commanding 60% of US aggregate wealth in 1983 to commanding 79% in 2016, while at the same time, the US middle-income bracket was whittled away.

Where are we now? Historically low interest rates for most of the last 15 years, coupled with quantitative easing after the Global Financial Crisis and government stimulus following the Covid-19 pandemic, have acted to supercharge wealth inequality in the US and globally. Looking at Graph 3, we can see that in 2021, the top 10% of the world's wealthy raked in 52% of the world's income and hold 76% of the world's wealth, while the bottom 50% only pick up 8.5% of the world's income and 2% of the world's wealth. To drive the point home, the richest 1% grabbed nearly two-thirds of all new wealth worth $42 trillion created since 2020, almost twice as much money as the bottom 99% of the world's population. A billionaire gained roughly $1.7 million for every $1 of new global wealth earned by a person in the bottom 90% over that period. In 2019, Oxfam found that the 26 richest people in the world (a busload) had the same level of wealth as the poorest 50% of people, and it has only worsened from there.

What does this have to do with investments? Well, surging wealth creation among a privileged few has led to some interesting outcomes in the world of investments. The world's richest man at the time of writing this article is Bernard Arnault, chairman and CEO of LVMH Moët Hennessy Louis Vuitton (LVMH), which has just become the first European company to reach a $500 billion market cap, surpassing Novo Nordisk and ASML in 2nd and 3rd place, respectively, in terms of the most valuable European companies. Hermès, a quintessential luxury company still owned by the family after almost two centuries of operation, holds the 5th spot, while Dior, another luxury company, takes the 7th spot on the podium in Europe.

But is it just Europe? No. LVMH is now the 12th largest company in the world by market cap, just under Taiwan Semiconductor Manufacturing Corporation (TSMC). It should certainly turn heads that the world's markets choose to value LVMH, a luxury conglomerate, at roughly the same level as a company integral in manufacturing the world's most cutting-edge technological building blocks – semiconductors.

Graph 4 shows that contemporary art, a luxury many aspire toward but only the successful can invest in, has outperformed the stock market, even with dividends reinvested, since 1995, along with gold, US corporate bonds, and real estate. At RealFin Capital Partners, we take pride in our expertise in appraising alternative asset investments. In the past, we have acquired contemporary art on behalf of our Multi-Family Office clients. From 2012 to 2022, the most coveted Burgundy Wines, represented by the Burgundy 150 Liv-Ex Fine Wine Index, also outperformed equities, racking up a 12.88% compound annual growth rate compared to the S&P 500 total return index's 12.56%.

At RealFin Capital Partners, we understand that luxury companies, contemporary art, and fine wine make for extraordinary businesses and investments, as somewhere in the world, some groups of people are becoming exceedingly wealthy, whether they are Russian oligarchs, Chinese venture capitalists, or South American salmon farmers. We believe this is why Hermès has been able to maintain a franchise since 1837, built on furnishing Europe's royals with saddles, harnesses, and bridles for the carriage trade. Over time, wealth changed hands, but timeless beauty and man's insatiable aspiration for status have remained. Hermès today is one of the longest-lasting family-run businesses on the planet and maintains a brand-equity coefficient unparalleled on the world stage.

While we believe luxury businesses will always be lucrative, high-returning businesses due to their Veblen qualities (goods for which demand increases as the price increases), leading to extremely strong pricing power, they also have a capped volume to some extent, as items must remain rare or at least perceived to be rare, which usually keeps a lid on expansion. Similar qualities exist for contemporary art and fine wines.

The overarching fact history has taught us is that the "haves," or the excessively wealthy minority, cannot keep expanding their share forever. At some point, this circumstance reverses voluntarily or by other means, and the cycle starts again.

Luxury houses will be brilliant businesses for decades to come, and it is likely that Hermès and LVMH's brands will stand the test of time. However, due to the trajectory and fervour of recent wealth distortion in the world economy, we would urge some caution regarding luxury equities, at least from a cyclical perspective driven by the financial gravity that history attests to.

[1] Contemporary Art: Repeat-Sale Pair Index of Post-War and Contemporary Art (as defined by the applicable auction house) using Standard & Poor’s CoreLogic Case-Shiller. The Standard & Poor’s CoreLogic Case-Shiller Home Price Indices Methodology results in a value-weighted index; auction results realised in a currency other than US dollars have been converted using exchange rates provided by FRED (St. Louis Federal Reserve) at the time of the most recent sale; this adjustment is made to account for long-term exchange rate trends that would otherwise distort artworks’ appreciation.

29 June 2023

The Path To Luxury
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