The binge on designer brands is over. After three years of record growth, luxury companies are feeling the pain as sales slow to a more normal pace. On Friday, an earnings report from Cartier owner Richemont offered up the latest evidence, and sent luxury stocks reeling. “I’d say a soft landing is our hope, but we will only know that when we look back at it probably in a years’ time,” Richemont Chief Financial Officer Burkhart Grund told investors during a quarterly earnings call on Friday. High interest rates around the world means that consumers are shopping less, moderating annual revenue growth in the sector to about 9%. China’s slower-than-expected recovery, as well as foreign exchange fluctuations have also pressured travel-related purchases and eroded profit margins. Amid this unfavorable backdrop, investors may want to look toward the defensive names in the sector — those that sit at the very top of the brand prestige pyramid. Nowhere have the struggles of the luxury sector been more prominent than in the French conglomerate LVMH Moet Hennessy Louis Vuitton , the group’s bellwether. Share value jumped more than 200% from March 2020, the start of the pandemic, to April 2023, when the company became the first European company to exceed $500 billion in market value after posting record results in 2021 and 2022. However, U.S.-traded LVMH shares are down more than 30% from the July high, after hitting a fresh 52-week low of $137.31 in trading on Friday. The company remains up 2% year-to-date after third-quarter revenue growth slowed to a 9% year-over-year gain in October, a sharp decline from 17% annual pace in the prior quarter. LVMUY YTD mountain LVMH shares in 2023 Luxury peers such as Gucci parent company Kering and Richemont also enjoyed a boost in the wake of the pandemic, bringing the sector’s revenue growth rate from 2019 to the first half of 2023 to 11%, or 200 basis points above the 20-year trend, said Bank of America analyst and head of consumer discretionary Ashley Wallace. She added that luxury stocks are trading below their historical averages. “The crux of the luxury investment case is now whether we shall see ‘gentle’ growth normalization through a ‘soft landing,’ or whether we will see a dip and a spend[ing] ricochet after years of consumers splurging,” Bernstein analyst Luca Sola wrote in a September note. While the richest consumers remain relatively insulated from a high interest rate environment and an economic slowdown, the aspirational consumer is more sensitive to these pressures and has begun to weaken. This dynamic tends to hurt the less-prestigious luxury brands more, according to Rogerio Fujimori, an analyst at Stifel. “What you have is basically companies that suffer less and suffer later. Usually, every time you have a slowdown period, it’s the more aspirational tier-two brands that suffer first. So you have to put that in this context,” said Fujimori. Nonetheless, he noted that no company is “fully immune.” The trend is already visible in the U.S. luxury market, which had been one of the strongest parts of the post-pandemic rebound, but also is the most cyclical, according to Wallace. “It’s important to understand that this normalization is coming from a point where demand has been elevated versus history,” said Wallace. “I don’t think that we should be calling into question the structural appeal of the sector.” Wallace expects the sector will “undershoot” on year-over-year growth for the second half of this year and into 2023. Currency headwinds The relative strength of the U.S. dollar compared to other major currencies has been a double-edged sword for the sector. During the summer of 2022, the gap between the U.S. dollar and the euro created nearly a 30% discount between EU-sold and U.S.-sold luxury goods, and led to a surge in U.S. travelers splurging on luxury goods in Europe. The weak Japanese yen also put luxury goods prices in Japan on par with Europe, attracting Chinese tourists to Japan for shopping sprees. However, the renminbi has fallen to its lowest level in 16 years as concerns over China’s economy mount, reducing Chinese consumers’ incentives to shop abroad, according to Wallace. This is critical. China is the biggest market for most luxury brands. Pre-pandemic, more than 60% of the luxury purchases made by Chinese consumers were made outside of mainland China, according to Stifel’s Fujimori. The number fell to a range between 10% and 15% during the pandemic. For LVMH, Kering and Moncler, the share is hovering around 30% year to date. “The luxury consumer tends to spend more when they travel versus when they are at home,” Fujimori said. “Chinese [consumers] are back to Southeast Asia and Japan, but there’s still a long way to go in terms of Europe. And that is probably something that’s continuing into next year. But that’s why you need, of course, Chinese consumer confidence — probably renminbi that is stable, because if the renminbi gets weaker, you have less purchasing power to pay for your trip,” said Fujimori. The companies do have the advantage of pricing power, which allows them to pass on currency moves over time to protect profitability and hedge, said Fujimori. “But the problem with currencies is [that] usually there is a shock when you have a very big move because that creates price gaps among regions. And the companies don’t increase prices straightaway,” said Fujimori. Unfavorable foreign currency movements also weigh on luxury company profits. Richemont reported that gross margins in its fiscal second quarter fell 2% from the prior year when using actual exchange rates — but were actually up 15% at constant exchange rates. Waiting for China’s rebound Luxury stocks may have no choice but to hope for tailwinds around China’s reopening. “There are and have been for quite a while elements that in general weigh down on the Chinese economy and especially on the feel-good factor on which we, as an industry, depend on,” Richemont’s Grund said. The sector will be especially sensitive to Chinese consumer sentiment next year as consumers in other regions have already slowed down. American consumers have already seen seven quarters of sequential acceleration in demand, at more than three times the normalized growth rate, before hitting a peak in the first quarter of 2022. Growth is slower, but still positive. European consumer demand peaked a year later, said Wallace, who forecasts luxury consumption in the region will decline 6% next year. Wallace expects consumption in Japan to peak in either the fourth quarter or the first quarter of 2024. “Next year, the Chinese consumer will contribute probably more than 70% of incremental revenue. So you’re highly reliant on growth from the Chinese consumers,” Wallace said. If the Chinese economy enters a stagnation similar to Japan’s economic growth in the 1990s and 2000s — the “lost 20 years” — then Fujimori foresees risks ahead. “After the U.S. and Europe reopened [post-pandemic], there was a bit of ‘revenge spending.’ … But in China, it didn’t happen. Confidence is very low, and youth unemployment is high,” Fujimori said. “Most of the wealth of wealthy Chinese is basically tied to the stock market and property market, which [have] been weak. So as you can imagine, [they] don’t feel a lot of confidence to make a big purchase.” Defensive luxury picks Amid the period of macro and consumer uncertainty, investors are favoring companies with defensive attributes that can withstand a tougher, slow growth world amid high rates. “The sector is seeing very little top-line growth at all. As we kind of enter into the ongoing normalization phase in terms of revenue growth, people should be positioned in the most defensive way possible until we’ve paddled through this weakness of the top line, and can start looking at better trends to come in the second half of next year,” said Wallace. Analysts are bullish on Hermes and Brunello Cucinelli , which are currently outperforming in spite of weakening consumption. These companies are more resilient due to their greater exposure to a high-net worth customer profile, which is less cyclical and more resilient against macro headwinds. HESAY YTD mountain Hermes’ U.S.-listed shares, year to date. Hermes also benefits from being less exposed to travel industry, Citi analyst Thomas Chauvet said in an October note. Hermes and Louis Vuitton have been more resilient in past recessions, Fujimori said. “I think perhaps because in less favorable times, consumers become more selective and buy fewer units — and the fewer purchases are concentrated on the stronger brands,” he said. U.S.-traded shares of Hermes and Brunello Cucinelli are up nearly 29% and 18% year to date, respectively. Shares of the two companies also were weathering Friday’s sell-off well, with Hermes unchanged, while Brunello Cucinelli gave up about 2%. That contrasts with LVMH shares down 3% and Kering shedding more than 2%. Hermes also benefits from being more measured in its price hikes compared to brands such as LVMH-owned Dior and Louis Vuitton, said Vontobel Quality Growth Boutique analyst Markus Hansen. “There were some egregious pricing moves by certain companies. And that maybe is now going to come back and bite a bit, because I think the nature of the price increases was maybe a bit too aggressive,” said Hansen. Bank of America’s Wallace expects Hermes will play some catch-up in pricing in 2024. “So there’s more still to come from them, which should be supporting their top line growth. And this kind of strong top line, supported by pricing and volumes, should help to give them better incremental margins as [we] go into next year, where margins in the sector will potentially become under more pressure,” the analyst said. To be sure, the U.S.-listed stock has an average rating of a hold from analysts. The average target price on shares is $210.50, which suggests shares could rise about 14% from Thursday’s close, according to FactSet. Analysts are less optimistic about Kering — the parent company of Gucci and Bottega Veneta, among others — as several of its brands are in turnaround mode under relatively new creative directors. It’s also more exposed to an aspirational customer. U.S.-traded shares of Kering have fallen 17% in 2023. Product categories are also important when considering growth possibilities amid a slowdown. Fujimori underscored aspirational categories, or items with higher price points and more discretionary in nature, such as watches, are more volatile and sensitive to market changes than perfumes. Beauty is generally more recession resilient, he noted. Underscoring this point is LVMH-owned Sephora’s outperformance compared with the conglomerate’s other segments in 2023. Flexing its pricing power Despite the difficult near-term environment for luxury companies, the analysts remain confident in the sector’s structural strength and longer-term growth opportunities. “That 9% compound [revenue] growth, if you take a medium-term perspective, is really supported by the fact that you have an addressable market which has more than doubled thanks to product extensions and cultural relevance, which has gone up significantly,” said Wallace. “Both of those things together support positive volume and price benefits.” An increasing number of high net-worth individuals from emerging markets also helps its structural long-term growth story, said Vontobel’s Hansen. That, combined with its supply-driven model gives companies resilience, he said. “As wealth improves over time, you have a product which is selling to a consumer where the numbers are growing but where the supply of the product itself is still behind demand. And that’s what allows you this amazing pricing power,” Hansen said. Longer term, the European luxury sector may once again contain opportunities for growth investors. LVMH and other European luxury brands have been market leaders among European equities since 2021 until the first half of 2023. The luxury industry also has strong barriers to entry, pricing power and no meaningful competition — which remains unchanged because the long-term fundamentals are unchanged, Fujimori stated. The brands are also timeless. This ensures that the luxury powerhouses can retain their market share and prestige in the long-run. “The luxury brands are basically the same leading players for many decades. That hasn’t changed,” said Fujimori. —CNBC’s Michael Bloom contributed to this report.