Having lived in San Francisco since the late ‘60s, I have some sense of what it feels like when the earth moves violently, but nothing like the recent earthquake in Japan. The 1989 Loma Prieta earthquake, which registered 6.9 on the Richter scale, caused a lot of damage and loss of life (and was plenty scary). But the recent Fukushima earthquake registered 9.0, and to date the amount of damage and loss of life hasn’t been fully tallied. To give some sense of the relative power of those two events: Loma Prieta delivered an approximate 405 kiloton punch; Fukushima experienced a 476 megaton hit.

When natural disasters, political unrest, or other dramatic world events unfold, retailers often worry about supply chain shocks. But one of the underlying storylines of the Japanese disaster is that one sector of the global retail industry took an extraordinary hit from a demand shock. Japan is famously one of the world’s great markets for luxury items, from extraordinarily pricey jeans to high-end jewelry. But with the events unfolding, all of Japan has understandably been focused on the basics of living, not luxury.

According to most reports, Japan represents about $20 billion of the world luxury retail markets, about 11% (second only to the U.S.). Many of the publicly traded retailers took a tremendous hit on the stock markets on the news of the Japanese disaster. For example, in the days immediately following the earthquake and tsunami, Tiffany & Co.’s stock plunged over 11% immediately after the March 12 earthquake (Japan contributes a reported 19% to the company’s sales) while Coach dropped about 10% (Japan = 20% of sales), and Hermes Intl fell about 7% (Japan = 19% of sales). Certainly, the financial markets were expecting events in the #2 market to alter those companies’ near term fortunes (although all of the mentioned stocks have recovered to some extent in the weeks following).

Canary in a Coal Mine?

Conventional wisdom argues that the luxury market is one of the last sectors to be impacted by recession, and so it was disturbing to industry watchers in 2009 when the sector took a deep plunge — by some reports, more than 20%. But according to a Women’s Wear Daily article on 10/19/10, industry watchers were almost giddy with anticipation of a recovery:

From hell to heaven in 18 months, ” said Bain & Company partner Claudia D’Arpizio of the luxury goods industry’s trajectory from the gloom of the 2009 recession to the recovery in 2010. “The market survived its worst crisis in 15 years and now seems to be in good shape, ” D’Arpizio said in presenting Bain’s study during a convention organized by Italy’s luxury goods association Altagamma. Bain estimates “the personal luxury goods category will grow 10 percent in 2010, reaching 168 billion euros, or $234.7 billion at current exchange. “

The March 2011 earthquake and tsunami changed the sunny outlook, and fast. Reuter News reported a spreading pessimism on March 15, 2011:

A more negative for the luxury goods companies would be if the nuclear accident burdened the general global mood. Luxury sales depend on people’s confidence, ” Swiss asset manager Sarasin said in a note. Regardless of what happens next in Japan, European luxury stocks are likely to struggle in the short term. “As far as the European consumer sector is concerned in the wake of the earthquake, we believe that the ‘early cycle’ recovery rally in luxury now seems vulnerable, ” MF Global said.

What will happen next? Recoveries aren’t bound purely by logic, and retail in particular is an emotional business. People spend when their confidence is up, and hold on to their money when times are tight. To the extent the conventional wisdom is true about luxury retailers, you know a recession is bad when the well-to-do constrain spending, whatever the reason. Conversely, when they open their wallets, it’s a good sign for everyone else

This is a sector worth watching, regardless of which vertical your company operates in.