Thursday, April 30, 2009

A grumpy market watcher

So markets are up and racing again. Everyone seems to be hooked on optimism and seeing those ' green shoots' of recovery spouting everywhere - except me and a few other middle-aged Jeremiah's. Sure, I can accept that the plunge towards armageddon has stopped/moderated but I can't see where the sharp rebound in demand is going to come from that will justify current multiples. Can't really believe that economies are going to grow when credit is contracting - even allowing for all the stimulus that's being pumped in .

I guess if I look hard enough there are some positive straws blowing in the wind.The Bank of Japan said this morning that it expected further contraction in the economy with a forecast of a negative 3.1% GDP figure this year against the previously posted negative 2% number. Having said that , factory output actually rose 1.6% last month for the first time since Q3 last year leaving Japans ouput down a mere 34% from March last year. That's ok then.

In Europe, Germany's jobless level rose less than expected to 8.3% from 8.1% but the tentative 'green shoot ' is promptly trampled on by the additional information that a further hike in unemployment by 1 million is expected over the next year. With a collapse in credit fuelled demand there is a lot of excess capacity floating around in those exporters around Stuttgart which everyone assumes is going to be utilised again quickly. I'm not so sure.

Am grudgingly watching the market go up.However, the banks , which have led the charge upwards,seem to be living in denial.Do they disagree with the IMF's view that they need another $4.5 trillion in order to recapitalise to viable levels? I'm waiting to see the fudge that the stress tests will bring whenever they are eventually released - on or about May 4th.Since when has a bank balance sheet leveraged 33 times been prudent? After the wonderful creativity in the financials Q1 results ( almost as fictional as the burlesque that passed for the Chancellor's UK budget )perhaps we can all get on with looking at further downside earnings surprises,jaw dropping commercial real estate and credit card writedowns,and accelerated deleveraging that will continue to starve industry and the consumer. Some of the sector will see effective nationalisation.With credit contracting at the rate it is, a lot of those German factories are going to be staying idle for some time.

It's painful seeing the market surging but I'll wait for the savvy, strong balance sheet market leaders see their share price come off and then step in and buy them . For the time being I'll stay unfashionable risk averse let others view Chrysler's impending bankruptcy and a further fall in UK house prices as positive news.

Tuesday, April 28, 2009

An 'L' shaped recovery until Q2 2010 ?

Based on 30 years of following them in the City, the airlines continue to provide me with a pretty good feel for what is really going on in the economy.
  • IATA's latest survey of management in the sector says that expectations for the next 12 months have moved away from indicating further sharp declines in profitability. There is a view that traffic expectations will remain stable at these levels for the next year and that yields will remain weak for both cargo and business.
  • Only 50% of airlines have secured funding for aircraft deliveries in 2009 and H1 2010.60% of airlines believe the funding environment has worsened in Q1 to such an extent that it is now unavailable - probably a view Boeing and EADS are coming to share.
  • At the operational level OAG says that for April airlines around the globe have scheduled 6% fewer flights than this time last year. This is the ninth month in a row of reductions with 136,000 flights and 9 million seats removed from last years levels.
  • Within Europe scheduled flights were cut by 8% for a 7% fall in the number of seats available. The UK was worst hit with the number of domestic flights contracting by 13% and seats by 14%. Internationally British airlines have cut their flights by 10% and seats by 9% to the lowest levels since 2001.
  • British Airways management has a pretty good history of telling it as it is - the CEO said on Reuters that he didn't expect to see an upturn until 2010 and that the economy will get worse before it gets better.

AIG has received three offers for its ILFC leasing unit - all are below $5 billion - a pale imitation of the divisions value a year ago.

So there we have it. Some signs from the airline managements that the collapse has moderated to a manageable pace but no signs yet that either the business or vacation traveller is stepping up and spending more. Still makes me think that I'll be able to buy back into equities at a more attractive price as markets readjust valuations for continuing weak demand and poor bottom line numbers. It also hints to me ( as a purely unscientific guess ) that the US and EU economies post-recovery will be unleveraged and probably 10% or so below its 2007 peak in terms of turnover. That would indicate that a lot of companies that have expanded are going to find themselves with a lot of excess capacity and the associated debt and inefficiencies that go with it. Risk seems to be in fashion but I'll eschew smaller co's and stick with big balance sheets, growing market share, pricing power and visible earnings.

Sunday, April 26, 2009

Is inflation the key to the market rally?

The UK government budget unveiled on Wednesday of last week left me speechless. It wasn't so much the massaged numbers and overly optimistic growth forecasts that alarmed me. Rather, it was the singular lack of urgency in attacking the imbalances. Any self respecting company that found that its fixed costs were clocking up to a rate of 125% of revenues would have quickly wielded the axe to overheads. However, UK plc seems to think that it can wait for three years before starting to trim expenditures. Government supporters will say that now is not the time to reduce demand by cutting back on expenditures. That's true. However, what we are then saying is that as most of the UK's borrowings are denominated in sterling the government will fund this gap by printing money - thereby sparing the taxpayer from shouldering all the pain. If that's the case then strap yourself in for the coming wave of inflation. The real crisis will hit the UK if demand doesn't turn up sharply - in that case there will need to be startling budget cuts - cancellation of Trident, reductions of salaries in the public sector, real cuts in NHS spending and ever higher government borrowing costs

I've been agonizing over the recent rally in stocks. Being 60% in cash, 30% in bonds and 10% in stocks hurts.Why have I been so wrong? Could it be the rally in the FTSE over the last month is a recognition by institutions that governments have opted for inflation to get them out of this mess?. At this stage of the inflationary cycle beaten down stocks must represent a pretty good 3 year option .

Monday, April 20, 2009

The devil is in the detail.

The headline in the FT said ' Bank of America profit triples to $4.2bn'. Not bad said I thinking my cautiousness about the market might be misplaced. The headline quote from the CEO was upbeat ' The fact that we were able to post strong,positive net income for the quarter is extremely welcome in this environment'.

Then I read the small print - the numbers were boosted by one off items - a gain on the sale of China Construction Bank for $1.9bn and $2.2bn of gains on widening credit spreads. Ex these out and the expanded operation ( post the acquisition of Merrill and Countrywide ) would have been breakeven. Credit quality deteriorated with charge-offs rising from $2.72bn in Q1 '08 to $6.94bn in the year later quarter. Non-performing assets tripled to $25.74 bn and the credit card operations lost $1.77bn.

The market seems to believe that these 'better than expected' numbers point to a recovery in this 'stricken' sector. That may be right , but to me it makes the stock look expensive on the real underlying numbers and the deterioration in credit quality makes me fearful that more capital raising will be needed.

Saturday, April 18, 2009

Am I missing something?

It must be advancing middle age. I just wish I could get more gung ho on this stock market rally. Even the news that the market is now only down 44% from its peak and that the 50% off everything sale is over doesn't make me bullish. All I can think is that at 44% down I need 75% upside to get the pension plan back to where it was. Having said that the trading desks are arguably right in saying that the economy's contraction is slowing and can probably wring more upside out of the market even though this coming week sees a rash of probably disappointing earnings numbers. The unknown in all of this rosy market outlook is the snowballing scandal over Mr.Hervesi and the New York State Pension Fund - it probably isn't as bad as some of the rumours are suggesting but there again I didn't believe that Madoff had sequestered $50bn!

Yes,the bank numbers over the last week looked better than expected but with the sheer scale of Federal cash sloshing around in the system is that a surprise? Also a quick scanning of the notes to the accounts takes me back to the days of being an analyst - the devil is in the tiresome detail and there is sure a lot of detail in Citi's ( and GS's and JPM's ) earnings release. From what I can see this downturn is being more destructive of loan books than anything in the last 30 years. Returns on corporate bonds post default seem to be running at around $0.30 - at this rate all the bank capital raised over the last two years is gone. If I'm right then there is going to be another round of capital raising and lending books are going to remain extremely tight. Just wait until credit card defaults and Commercial real estate impairments start to kick in . I come full circle to my bugbear that unemployment is a major driver of loan defaults and that bank loan books are sick and getting sicker.

I see Blue Wings ,a Russian oligarch owned airline in Germany, has filed for bankruptcy. If the oligarchs can't keep their day to day operations going what does it auger for all those banks who lent to Moscow and were secured against much stronger commodity prices and a robust rouble? If Barclay's equity is about 3% of its assets, and loan loss provisions are about 0.3% then further trouble might lie ahead. I'll do the numbers on Deutsche ,which is even more exposed to Russia, but would expect the numbers to look much the same.

Sterling has been rising this week. I'd love to believe that quantitative easing is working and getting the UK economy on track but with money supply growth of 19% inflation looks like a very scary possibility- as we're still on the deflation/inflation fence we've added a bit more gold to the pension pot below $890.The Chancellor announces his budget this coming week so it may be a question of selling sterling on the news - after all what can the poor guy do ahead of an election? Tell the voters that there are going to have to be huge cuts in public sector funding? The news
that building societies are on the hook for £50 billion of self certified and highly dubious ' whole-loan sales' couldn't come at a worse time. These fast track applications seem to have received little or no scrutiny by the FSA.

We're beginning to reshape the pension plan for the ten year view by switching into blue chip plays with good cash flow and market share. This downturn is going to wipe out excess capacity through consolidation - interestingly FIAT added 10% yesterday on the view that a deal with Chrysler will be completed within the 12 day deadline. The survivors are going to have both improved market share and increased pricing power - the weaker players are simply going to go. The better managed companies have reduced inventory and have recognized that capacity utilization isn't going anywhere fast. Talking to managements over the last week there doesn't seem to be any great rush to use cash to make acquisitions just yet - the view from those I've talked to is that as the pain in the economy increases prices for viable companies with stretched balance sheets will get even more attractive. The pressure on third and fourth tier suppliers is dreadful.I guess that there is going to be massive differentiation in equity valuations going forward- that's the real opportunity here.

Thursday, April 16, 2009

Is this the bottom?

Remain confused by the Goldman results but can see that the Wells Fargo and JP Morgan numbers were reasonable. The market and the media are enthusiastic about the discovery of these first green shoots of Spring and are probably right in their view that the S&P at 680 was discounting armageddon. In this more optimistic vein it seems that discussion of the bear market rally has been replaced in the financial news networks by a view that this rally has 'legs' and that the S&P can top 1,000 in short order.

Yet, underlying this upbeat outlook I can't but help feel that there is something wrong. In thirty years in finance I've always found the airline numbers to be a pretty good reflection of what's happening in the real economy. Looking at the latest numbers from IATA it would seem to me that the bottom of the cycle may arrive in early Q3 but any rebound is going to be anaemic with yields not rising until 2011. US carrier dometic yields are shrinking fast , falling 14% in March .That darling of the Street,Southwest Airlines ,has warned that it may be driven into bankruptcy with the toughest revenue environment in its history and no bottom in sight..Premium revenues for US and European airlines fell about 30% in February which will exert strong downwards pressure on Q1 numbers.Making matters worse the reduction in yield across the Atlantic last month was the worst in a decade - beating even the post 9/11 decline.

I can see the Dow continuing to rise towards 9,000 but I'd like to see the airline traffic figures for May before believing that this is a structural change. My fear is that we may be closer to hitting bottom but the recovery at the tail end of 2009 will be extremely muted and the cashflow and balance sheet ramifications of over capacity are not yet discounted.

Monday, April 6, 2009

Dire wasn't good enough to keep this rally stoked - BA, Air Canada, Airbus

It looks as if common sense has reasserted itself and markets are waking up to the fact that 'dire' data doesn't equate to good data. Sure, some of the numbers last week could have been worse but they sure weren't an excuse for the recent rally to continue. The whole thing has slightly had the feel that the trading desks were getting ahead of themselves. Today's desperate rumours that the Abu Dhabi Investment Authority may buy Opel is a sign that the recession is really biting and that we are segueing into the stage where consumer demand slumps, savings rates soar, and bankruptcies start to appear on the front page of the papers.None of this is good for earnings over the next nine months at least.

I'm still hugely negative on the banks believing that their balance sheets simply aren't stressed to stand the level of corporate and consumer delinquencies that are on the way. We have to see a wave of capital raisings a la HSBC in order for the banking sector to continue to function and that's going to be massively dilutive.

The G20 meeting was great. Nobody promised the earth and the leaders were remarkably sensible in their criticism of protectionism and their mutual agreement not to do too many stupid things. This is a huge result.

The retracement continues to work its course:

BA expects to make a £150 million operating loss in the year to end March '09 and will also take £75 million of redundancy costs. Downward pressure on yields and volumes continues.

Air Canada trans-Atlantic passenger traffic down 15.6% y-o-y

Austrian Airlines is reducing pilots salaries by 8.5% and pension contributions by 75%!

The owner of London's Evening Standard newspaper said he would be cancelling an order for 20 Airbus A-320's following the German Federal Aviation Agency's revoking of the operating license for BluWings.

UK new car sales fell 30.5% in March y-o-y

Sunday, April 5, 2009

Less worse?

Stockmarkets continue to surge on hope that the first green shoots of recovery are appearing. Traders in London are covering their short positions and looking beyond weak corporate numbers over the next couple of quarters to 'normality' by the end of the year. Normality by most appearances will be an improvement in negative growth from 6% in Q1 2009 to minus 2% in Q4 with anaemic growth of around 1.5% in 2010 as unemployment rises to 10.5%. To me valuations look stretched against this backdrop and are probably getting ahead of themselves.

Looking at the data over the last week I suppose you could say that it could have been worse but it's still pretty dire. With the banks repairing their balance sheets and cutting back on lending I can't help but feel that any recovery in consumer demand is likely to be tepid even with lower mortgage and gasoline costs boosting purchasing power.

Exports of Australian wines fell for the first time in 15 years. In 2008 the value of wine exports to the UK and US shrank by 17% and 23% respectively.

Bankruptcies in the US during March are running at 5945 a day - the highest rate since 2005

April foreclosures are likely to rise after the moratorium on sales and evictions on properties owned by Fannie Mae and Freddie Mac ended on March 31st.

In March the number of people in the US involuntarily working part time rose by 423,000 to 9 million.