Watch Price Crash? – Coronavirus Watch 14

It’s no secret: this site takes a jaundiced view of the watch market. Coronageddon, watches not being assets, watch prices falling, that sort of thing. Not to mention the fact that this website’s proprietor once wrote a 250-part series called the GM Deathwatch for The Truth About Cars. Well, you know what? He was right about GM. Is he right about Coronageddon causing a major watch price crash?

If you read the watch press, no. There’ve been a spate of articles recently about how demand is up despite what is going on in the world. Here’s the headline of one, remarkably and shamelessly filed under “News/Research” despite it reading like a press release: 

This is a very clever bit of sophistry. The first sentence reads:

Demand for Rolex watches rose by 11% in the month since March 26 and Heuer demand is up by 19%. Blancpain demand rose fastest, by 37%, although the sample size is certain to be much smaller.

Can’t argue with that! It even uses the quasi-scientific terms “sample size” to give itself the sheen of precision. And then:

Rising demand is defined by the number of searches for a particular item or brand, so 11% more searches for Rolex, the company also says that prices have held firm during the Coronavirus pandemic and registrations are up.

Oh, you’re defining demand by number of searches? If one of my employees came to me and said “Mr. Adams, sir, demand is through the roof! We’re seeing so many hits on our website,” I would look up from my laptop and set them on fire with my mind. 

But enough of How to Lie with Web Statistics 101. To understand why we think there will be a watch price crash, it will help us to look at both sides of the market: supply and demand.

Supply: Don’t expect too many changes

We all know that Rolex, Patek, and numerous other brands shut down production last month and pulled launches. Never mind a watch price crash. This has some predicting an upcoming supply crunch that will drive prices up for “desirable pieces.” (Oh yes, the eternal “desirable pieces” canard, which allows you to be irrefutable since you can change its definition at will.)

Here’s a little secret of business: nearly every company is set up to produce a certain quantity of goods over  a certain amount of time. When they have to produce too many or too few, bad things happen.

Swiss watch manufacturers are no different. While they might use marketing bs like atelier or workshop, most of these guys are manufacturers at scale. Rolex alone produces somewhere north of 800,000 units a year. Little Patek is still well above 50k (with some estimates going as high as 75k+). 

Your Portugieser isn’t made by gnomes in an attic; these are businesses with employees and supply chains and fixed costs. Employees, suppliers, and landlords like to be paid. On time and in full.What happens what that stops? Well, we have a term for that exact situation: “bankruptcy.” 

And these brands don’t have infinite money to just keep paying people. The Swatch Group had about CHF 1.2B in cash at the end of 2019. On the other hand, it spends about CHF 1.8B every quarter to keep things running. If you can’t run your factories you can’t pay everyone, honor your contracts, or keep the lights on.

The Swiss are no different than Major League Baseball, Delta and Ford: they want things to reopen as soon as humanly possible. They need to move product because they won’t have a business if they don’t.

So they’re going to make every effort to get that product to the channel, even if it means devaluing their brands a little. (It also means that they’re looking very hard at increasing grail watch production as a temporary way to bring much needed cash in at the expense of some pain later.)

So we can see that supply isn’t going to change that much, at least on a macro scale. What about demand?

Demand: Financial vs the real economy

As we think about demand, it’s good to separate the financial economy from the real economy (this is often referred to as Wall St. vs Main St.). The financial economy consists of a supply of assets, a supply of investments, and a supply of money and they have to roughly find an equilibrium. The real economy is basically everything else: goods, services, wages, et al. 

The two economies are usually roughly in balance: the price of an asset generally reflects its real-world productivity and potential for income. This is good – it’s a heck of a lot easier to look at the delta of a company’s stock price to roughly understand if it’s doing well rather than do deep fundamental analysis. So we rely on the financial economy to tell us about the state of the real economy. 

Sometimes though, they get out of whack for whatever reason. Then you get the dot.com bubble, cryptocurrencies in 2018, or what just happened to commercial real estate. When the two diverge, the predictive value of the financial economy lessens.

Right now, it’s likely that we’re going through a period like that. US stock prices are flashing pretty green right now but the economy is shrinking at a nearly five percent annual rate. To understand what might happen to wristwatch demand, we need to look at the real economy, because it is usually the case that people’s income, not their asset base, drives consumption purchases.

Let’s look at the three consumer bases who make up most of Swiss watch consumption:

– The Middle East – How’re oil price doing? How low can you limbo?

– China – Despite absolute marketing BS swallowed by a willfully gullible horological press about “revenge buying,” China’s problem isn’t the virus right now. It’s an economy entirely dependent on exports having nowhere to export to. While I’m not a China bear, a huge amount of hard currency to spend on frivolities comes in from China’s exporters. And they’re not doing well:

– The US and Europe – hahahahahahahaha. O.K., sure.

So the engines that drive demand are slumping all over the world and will continue to do so for at least the next two quarters. How can it not lead to a watch price crash?

Pricing

I hear you screaming: where is this “watch price crash”? Where are all the discounts?

So far, apart from some “flash sales” and consistent downward pressure on Rolex and some other brands, there are not many screaming deals on high-end watches. Doesn’t that, in and of itself, show that supply isn’t outracing demand?

Not quite.

First, we don’t know actual transaction prices. Second, there are factors that affect the timing of price discovery.

The vast majority of watches sold new come from dealers who buy and hold inventory from the manufacturers (or wholesalers). They sold through most of their stock around Christmas and were likely reordering in early-to-mid January when Coronageddon hit. They’ve already paid for their inventory on offer. They need to recoup their costs. 

Because of this, every dealer is doing a short-term vs long-term calculation. Namely, should I hold out and see if I can get a better price down the road? If things are going to rebound AND there’s not an immediate cash need, it can make sense to wait. PPP, rent forbearance and employee furloughs lessen the pain of waiting – at least right now.

But what happens as the manufacturers reopen and start pressuring their dealers to take new inventory? When the pain in the real economy doesn’t go away and discretionary purchases like jewelry continue their downward slide?

Anyone can get by for a month or two; a quarter or two is much harder; more than that look out. Watches of Switzerland has about £50m in cash and about £120m in yearly expenses (excluding inventory acquisition). At what point do they look at their hundreds of millions of pounds of inventory as a liability, not an asset?

We’ll know by late summer if dealers (and therefore prices) are holding firm or capitulating. If the Christmas buying season is looking grim, there will be a rush to blow out inventory before Christmas, since the costs of holding excess inventory after mid-December will be very high. Combine that with a much better view of what the economy will look like in 2021 – if there’s no visibility on a rebound, expect capitulation.

What does this mean for you, the buying public? Despite the prevalence of hot “Buy now or be priced out forever takes,” there’s nothing to be lost by waiting. The real economy is not going to be appreciably better in July and August and our bet is that dealers will be sitting on a ton of inventory. That’s your cue to swoop in and get a deal.