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Is demand for luxury goods correlated with GDP growth? As a generalisation, luxury goods by their nature enjoy higher levels of demand as incomes increase and lower demand as incomes fall. Is this even truer now that the aspirational component of luxury demand has grown? Does it follow that, in times of economic downturn, the consumer will wave farewell to the Bond Street boutiques? What does this mean for the luxury sector that has enjoyed strong growth and performance in recent years?

Housing markets continue to cool, credit availability remains tight and labour markets soften. Economic conditions have, therefore, taken a turn for the worse across the developed world. We hardly need reminding of the weak equity market conditions that currently prevail. Yet despite this, global luxury companies continue to achieve healthy results.

There are very few domestically quoted UK luxury goods businesses, and one has to look overseas for the vast majority of global leaders in the sector. Nevertheless, two domestic companies with strong international sales have delivered healthy results. Burberry, which reported at the end of May, showed a 25 per cent increase in profits over the year, and Mulberry, the manufacturer and distributor of quality leather goods, reported a 14 per cent rise in revenues.

Furthermore, sector growth forecast in the region of 10 per cent for 2008 and beyond has been widely reported. Between 2003 and 2007, sales growth across the sector increased from 1-11 per cent, and many of the companies reporting lately will have seen significant follow through from these boom times.

The full impact of the credit crunch is taking time to bite, and it has been intriguing to witness consumer spending patterns in the domestic market remaining entrenched into the new year. Only more recently have overall consumer spending levels been falling significantly, with dramatic results for many general retailers. Rather than scaling back consumption in line with disposable incomes, which in the UK fell by 1 per cent during the first quarter of 2008, consumers have tended to borrow more, with the result that the UK savings ratio has now fallen to 1.1 per cent, its lowest level since 1959.

Forecasts of 10 per cent growth this year run contrary to any intuition that the economic downturn is truly biting. Why might this be? The answers arguably lie in the very international nature of the luxury market, its continuous evolution and development and the core customers who will drive demand.

In the first instance, it is probably the case that companies in the sector today are better run and better equipped, with leaner structures and stronger balance sheets than was the case in previous downturns. This does remain, however, a sector that is characterised by high fixed costs and a need to invest in brands to maintain and extend market presence, so any downturn is likely to be felt, as scaled-back production and fewer sales eat into profit margins. While larger companies, such as the sector giant Hermes, will absorb costs more easily, downside risk is inevitable to some extent as companies look to scale back investment in brands.

Luxury goods, by their very nature, create value through product scarcity and brand awareness. This enables them to achieve far higher levels of profitability than companies in the general retail space. Indeed, for many luxury brands, profits are between 10 and 12 times the cost of goods sold. Any move to reduce investment runs the risk of damaging the brand, removing pricing power. In a bid to preserve brand exclusivity, it has been interesting to see a number of companies launching recent substantial counterfeiting claims.

So where is the growth expected to come from? Reporting at the end of May, Tiffany & Co announced a 12 per cent increase in worldwide first-quarter sales. Given that sales in the Asia Pacific region increased by 21 per cent during this period, there is no doubt demand from the emerging economies is driving growth and, with more planned store openings across the region throughout 2008, the company expects this to continue.

Historically, emerging markets have been hit hard by recessions in the US and Europe, but it appears this is not the case at present. Despite talk of a decoupling having not fully emerged, there has been a structural shift in wealth from the developed economies to the markets of the Middle East, Russia and Pacific Rim as a result of global imbalances and roaring commodity markets.

This is particularly evident in a country such as India, where domestic annual growth for 2008 is forecast at more than 8 per cent, which includes a measure for a fall in export demand that accounts for 13 per cent of GDP. A sizeable growth in the Indian middle class, where it is estimated that 600m of India’s 1.1bn population are now classified as such, means there are more people with disposable income to spend on luxury goods and services.

Companies that have benefited most to date are the early movers that already have a strong committed base in the emerging markets and have already absorbed many of the associated start-up costs. For the hard luxury goods, these are companies such as Swatch, Richemont and Tiffany, and in the soft luxury space, a business such as LVMH. LVMH also offers a diverse product range including high-end leather goods for which demand is expected to remain robust.

It has been particularly illuminating to see Tiffany & Co reposition itself, as it now offers a more diverse product range following deals with both Swatch and luxury sunglasses manufacturer Luxottica. This initiative was designed both to complement the core jewellery business and broaden the brands reach.

Growing inflationary pressures in the emerging economies do pose a threat. Given the reliance on these economies as key drivers of growth, any slowdown would begin to pose more significant problems. While growth is expected to slow in 2008-09 as compared with 2006-07, levels are still very healthy. Analysts foresee that a slowdown in excess of 15 per cent would be required to critically damage growth, but on a risk-reward basis, companies that are more widely diversified across the emerging economies may perhaps be preferred.

Were a downturn to materialise, it is arguable that the most exposed would be hard luxury players such as Richemont and Swatch, the latter having this year reported growth of 23 per cent in Hong Kong, 38 per cent in China, 72 per cent in Singapore and 55 per cent in UAE, which offset stagnation in sales in the US and a decline of 20 per cent in the UK. Currencies will also be important, particularly the relative movements in the dollar and yen. Further weakness in these two currencies would most likely impact negatively across the sector.

As Western economies apparently head into a downturn, and the number of high net worth individuals around the globe increases, the most exclusive and traditional brands should be best placed to benefit. Top-end companies such as Hermes or Chanel tend to be less cyclical. Those with considerable wealth are more conservative in their tastes and less aspirational in their spending patterns.

The ultra-high end of the market is still quite buoyant. Claude Monet’s Le Bassin Aux Nympheas, which was expected to reach £24m at auction, sold at Christie’s for £40m in June, breaking all previous records and showing there are still people with plenty of money around. The number of high net worth individuals rose by 6 per cent last year as opportunities for wealth creation through capital markets became more widespread, particularly in the developing economies. Ferrari reported unprecedented growth in emerging markets, with sales increasing by 47.2 per cent in the Asia Pacific region and 32.3 per cent in the Middle East.

As the rich get richer, they increasingly look for exclusive brands to differentiate themselves. In May, Swatch reported growth of 40 per cent across its top range products, while entry-level products grew at only 5 per cent and the intermediate segment declined by 2 per cent. Mid and low ticket brands are likely to experience more difficult trading conditions, and it is here that a business such as Burberry is arguably faltering.

Rather than seeking to move up the value chain or to diversify into the emerging markets, Burberry is seeking to increase market share by appealing to a broader and less exclusive consumer. This is a move that will almost certainly see its sales impacted over the coming months as aspirational buyers dry up. This is also consistent with the fact the luxury goods market in practice tends to be a latecomer to economic downturns.

Nevertheless, at the very top of the market, luxury will tend to be resilient even in the most difficult market conditions, as scarce, well-branded goods retain their cachet across the economic cycle.