Luxury Market Faces Prolonged Contraction

Jan 29 2009 | 9:03am ET

By James Kaplan -- Scene: The hearing room of the Senate Banking and Finance Committee. On the dais sits an impeccably-attired, dark-haired man with piercing eyes, flanked by assistants and reams of documentation. At the table facing him sit the chairman and president of the nation’s largest banks, names well-known to the public through their frequent commentary on financial issues as well as through regular news footage of their extravagant lifestyles.  The room shimmers in the rapid fire of flashbulbs.  The record has just revealed the chairman shorted his own company’s shares during the crash to profit from the falling stock price and the president authorized interest-free loans to senior executives while rank-and-file employees were laid off.

Although it sounds like last night’s news, the above scene took place in 1933, in hearings conducted by Banking and Finance Committee Counsel Ferdinand Pecora  which led to the passage of the Glass-Steagall Act of 1933 and the Securities Exchange Act of 1934.  Now, 76 years and some $750 billion later, the stage is set for a revival. 

After more than a decade, the salad days of easy money changing hands on Wall Street in an unregulated environment are over – as well they should be.  Of course, there have been many victims, and will be many more.   While the middle class has taken much of the economic punishment to date, the future looks particularly bleak for more affluent investors.

Hedge funds gained substantial popularity when the Internet bubble of 2000 finally popped, increasing from under 1,000 funds in the year 2000 to over 8,000 in the summer of 2008.  Restricted to “preferred” investors, to protect small investors from assuming the high level of risk, hedge funds avoid capital requirements and regulatory restrictions.  There are no professional standards for hedge fund managers. 

Not surprisingly, the number of fund players, encouraged by the investment banks, grew at a rapid pace, as did the assets under management, estimated at $2.5 trillion as of the summer of 2008.  As hedge funds grew, they became not only a home for the very wealthy ($5 million or more in invested assets), but were also marketed to investors of more modest (though substantial) means.

But the salad days are over for the affluent, too.  In recent months, hedge funds have been closing their doors or eliminating redemptions.  In a few cases the funds are shutting down because they recognize the lack of opportunity.  However, in most cases funds are liquidating because their asset values are deep underwater. 

Of greatest concern are those hundreds of funds that have stopped permitting redemptions.  This is a clear indication they hold assets that are not only illiquid but, most likely, are carried on the books at values for in excess of current market value.  In 2008, hedge funds lost $350 billion globally.   It would not surprise us if an additional $750 billion evaporates over the next 12 months.

This financial meltdown has significant impact on the future of hedge funds and their prime brokers, and will also impact the spending patterns of the affluent.  This has already been seen in the disastrous results of high-end retailers through Christmas, 2008.  Revenues were down 35%, according to Spending Plus.

We expect this trend to continue through 2009 and to actually accelerate on the downside.  The following is a list of service providers who cater to the high-end consumer, together with their most recent AGR® risk rating.


AGR rating *AGR Percentile
Harley-Davidson, Inc. Very Aggressive 2
Morgan Stanley Very Aggressive 6
Goldman Sachs Group, Inc. Very Aggressive 7
The Talbots, Inc. Very Aggressive 8
Coach, Inc. Aggressive 10
Perry Ellis International, Inc. Aggressive 11
Textron Inc. Aggressive 14
Constellation Brands, Inc. Aggressive 15
Tiffany & Co. Aggressive 16
Starwood Hotels & Resorts Aggressive 17
Polo Ralph Lauren Corp. Aggressive 20
Saks Incorporated Aggressive 21
Brunswick Corporation Aggressive 22

* The AGR® score ranges from 0-100, with corresponding ratings from Very Aggressive to Conservative. Companies rated Very Aggressive or Aggressive have proven to be much more likely to face class action litigation and financial restatements, and to suffer severe equity loss.

We caution our clients to be particularly aware of those companies that display a less than total candor with their shareholders.  In most instances these companies may still have some very nasty surprises to reveal.

James Kaplan is the founder and chairman of Audit Integrity, a provider of accounting and governance risk analysis on public companies.

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