China’s Malaise Spreads to Luxury Industry

China’s economic malaise is hitting smaller fashion rivals even harder. British trench-coat maker Burberry Group and Swatch Group UHR -0.08%decrease; red down pointing triangle, owner of the Blancpain and Omega watch brands, reported plunging sales in mainland China, while Germany’s Hugo Boss cut its sales guidance for the year. Richemont, the owner of Cartier, reported a 27% drop in sales in China, Hong Kong and Macau.

Luxury executives are divided over whether the downturn represents a passing storm or a more lasting shift in the behavior of Chinese consumers, particularly middle-class shoppers. High youth unemployment, declining real-estate prices and trade tensions have eroded consumer confidence in the country, prompting the middle class—which accounts for a significant chunk of luxury purchases—to save rather than spend.

Mining giant Anglo American said last week its De Beers diamond division would further reduce production in response to decreased spending by Chinese consumers, which has led to a prolonged market downturn.

“The middle class Chinese are on the back foot,” said Luca Solca, an analyst at brokerage Bernstein. “Swatch and Burberry take that straight in their face, as they primarily serve this constituency. Higher-end brands will also be feeling this headwind, but a lot less.”

LVMH, the industry’s largest firm, and Richemont say they’ve seen pockets of resilience in their China business, particularly among wealthier consumers who can afford to shop abroad. LVMH on Tuesday reported a 57% surge in sales in Japan, where many wealthy Chinese nationals are traveling for shopping trips to take advantage of the weak Japanese yen.

“We have a mixed situation, but not that bad,” said Jean-Jacques Guiony, LVMH’s chief financial officer.

Guiony said sales to the Chinese “cluster”—which combines tourism and mainland shopping—were up high single digits in the first half of the year for the firm’s core fashion and leather-goods division. However, Guiony added that the growth slowed in the second quarter. Sales to the Chinese cluster from the company’s watches and jewelry division, which includes Bulgari and Tiffany, were down overall, Guiony said.

Traffic in Chinese luxury shopping malls is down by a single-digit percentage so far this year, while luxury sales have dropped by a double-digit percentage, Solca wrote in a June note.

In response, many luxury groups have cut costs in China, scaling back their marketing efforts and delaying some real-estate projects. They have also focused more of their efforts on the country’s wealthiest consumers, who tend to splurge regardless of the ups and downs of the economy.

Guiony said brands that had reduced their marketing investments in China over the past few quarters were being penalized more than those that had maintained them.

“This is why we are keeping investing into this market, which is obviously a very important market for us,” Guiony said.

Luxury companies are also hitting turbulence in Western markets with consumers pressured by inflation and higher interest rates. LVMH said sales rose a meager 2% in the U.S.—a market that was once its fastest-growing and a key driver of its postpandemic boom. Sales climbed 4% in Europe.

Over the past two decades, the rise of big-spending Chinese shoppers has transformed the luxury market. Chinese consumers traveled to fashion capitals like Paris to hunt for handbags, and when the pandemic restricted travel, they flocked to Louis Vuitton, Dior and other boutiques across China. According to Bain, Chinese consumers accounted for around 23% of global luxury spending last year.

After a brief sales bump following the reopening from Covid-era restrictions, however, underlying economic issues began to weigh on demand in China. In recent months, economic indicators have been sluggish, with gross domestic product growth and retail sales falling short of expectations. Consumer confidence also continued to decline.

Expensive brands have a reputation for selling to the super rich, but they rely heavily on shoppers further down the income scale, too. Over half of global luxury purchases are made by individuals who spend less than €2,000 ($2,180) annually on high-end handbags, clothing, and jewelry, according to the Boston Consulting Group.

Chinese leader Xi Jinping and several hundred top Communist Party officials gathered in Beijing last week to plot the country’s economic revival. The blueprint released on Sunday signaled an intention to rev up growth in the coming months. Officials also promised to stick with the government’s 5% growth target for this year—a goal some economists consider challenging.

Still, the document offered little new on some of the thorniest issues, raising concerns among some economists about the country’s long-term prospects.

Some luxury executives say the economy’s structural weaknesses are likely to persist, leading consumers to trade down—from luxury to cheaper brands—further pressuring the industry’s biggest players like Louis Vuitton and Gucci.

Other luxury executives, however, are optimistic that trends will improve, citing the high savings rate among Chinese consumers. They believe that if the Communist Party’s initiatives succeed in boosting consumer confidence, a swift and robust recovery in demand could follow.

Many consumers are biding their time, Guiony said, saving up for trips to Japan. Prices there remain significantly lower than those in China on average, Guiony said in April. He said at the time that luxury goods in Japan were selling at around a 10% premium to European prices, whereas in China, they sold at a 20% to 22% premium.

“We really have a big shift of business from Asia to Japan,” he said.

Write to Nick Kostov at nick.kostov@dowjones.com and Stacy Meichtry at Stacy.Meichtry@wsj.com