Nothing new

There's been little new to post about in the investment landscape over the last three weeks. I continue to be wrongfooted by the markets renewed and voracious appetite for risk. Indeed most markets (China excepted) have continued to rise on the back of signs that global economies are stablizing and that the worst of the 'repression' is behind us. During this time in the wilderness I've added a few more corporate bonds to the portfolio and topped up on gold . Apart from that I'm content to wait until equities finish their all night partying and start to focus on the term paper that's due tomorrow. If recovery from this downturn is anything other than a very sharp 'V' then across the board P/E's will be exposed to sharply lower earnings growth,embeded excess production capacity and increased risk.

Corporate earnings in Q2 were boosted quite nicely by cost cutting including widespread layoffs. This trick can be repeated a few times but ultimately there is a limit to how much you can cut the workforce without impacting revenues. There's maybe another quarter of upside left in cost cutting but after that nothing. Elsewhere, there is at last some recognition that the banks can either repair their balance sheets by sitting on cash or , if we want them to lend, by raising fresh capital. Lloyds is talking about another $16bn. The smart players like HSBC were in early and are now gaining market share but the dilatory ones will have to hope that investors have forgotten what the word 'dilution' means. For holders of the banks it was a great run up while it lasted but for the 500 banks slated to fall under FDIC protection in the US over the next 12 months the outlook isn't as bright.

On the airline front demand in July was close to levels seen in '08 but with the caveat that there continues to be widespread trading down to cheaper,lower margin fares. Business to coach, first to business and so on. This will probably mean that revenues fall by around 20% on an annualised basis at the major carriers. They must be praying that they don't get hit with a hike on fuel prices. Yesterday, SkyEurope a low cost carrier in central europe threw in the towel. All eyes are on Septembers business figures - early indications that they are likely to be pretty dire and reverse any creeping sense of optimism about business travel. Ditto for hotels.

Todays London Times is talking about more than 130,000 jobs being cut in the National Health Service as part of government attempts to get its borrowing levels back under control. Multiply that by cutbacks and layoffs in other public services and the prospect for unemployment in the UK next year and in 2011 starts to look set to breech 3 million. What is consumer demand going to be like when unemployment soars and taxes, both direct and indirect, have to increase? Add to that higher,prudential savings rates and the outlook for consumer non-staples looks challenging This isn't doom and gloom but a reflection of where we stand in the cycle. I'm still wanting to buy into high yield , household name equities for the long term and hoping that I'll get a second chance.Gain shall take the place of loss.

BA,SAS,Swiss still in the midst of the storm

Markets have continued to drift gently higher since I last wrote - proving my upside market sense and timing to be out of step with prevailing sentiment . After the sharp increases of April and May which gave us the strongest bear market rally in history, there seems to be less conviction that the equity rally has much further to go amid signs that interest rates in the UK and US might have to reverse course and move higher. In the broader economy it's interesting to note that:

• Irish prices fell by 4.7% in the year to May - the steepest fall since 1933
• US household net worth ( including real estate,stocks, and bonds ) was off $14 trillion from its 2007 peak
• US May retail sales were off 10.8% from year ago levels - gas station sales were down 33.8% and car dealership sales off 19.6% from prior year levels.

I keep on looking for signs of 'green shoots' in the airline industry but all I see so far is proliferating weeds. If I could discern that corporate or vacation passengers were returning to their established travel plans then I would feel much more confident that we had hit a low point from which the economy was set to recover. In the airline sector, like the auto and banking sectors we are just beginning to see that consolidation and capacity reduction are needed to remove chronic over supply and restore profitability.

IATA has said that the worlds airlines are seeing few concrete signs of recovery and many of them are at a knife edge. Yields are crumbling and losses are widening at a hectic pace. IATA also revised its forecast for industry losses in 2009 to $9 billion a doubling from its forecast of $4.7 billion made just two months ago. After September 11 airline revenues fell by 7% and it took three years to recover. This time round revenues are down by more than 15% and the demand side is showing little sign of improvement.British Airways CEO says the carriers business faces 'serious threats' while Aer Lingus managements says this is the most difficult environment in its 73 year history.

• May 2009 Air France-KLM y-o-y passenger numbers down 7.8%. Asia Pacific down 10.9% and Trans-Atlantic down 9.3%.
• May 2009 SAS Group y-o-y passenger numbers down 17.1%.
• May 2009 SkyEurope passenger numbers down 37.5%
• Swiss CEO says that premium passenger and cargo demand has stabilized at a very low level and that prospects of a recovery this year are unlikely.

From the perspective of the airlines this economy ain't on the mend and higher fuel and financing costs aren't going to make it any easier to make a profit let alone survive. I'm told that Uniteds order for 150 new planes is dependent on the manufacturers finding the financing! I think we will avoid a depression thanks to government largesse but consumer expenditure hit by higher taxes,higher borrowing costs and higher unemployment is going to take a long time to recover. This now becomes a stock pickers market with sectors where demand is little impacted by a huge downturn in credit looking attractive no matter what happens to the broader indices. Pharmaceuticals fit the bill, as do restructuring plays, consolidation candidates, agriculturals and some precious metals.

The precipitous fall eases as we drift gently ever lower

The UK Sunday business pages are all studiously upbeat about the outlook for equities . Where once the analysis was all doom and gloom now its sunshine and roses. It can't be the weather that's making all the financial pundits happy so it must be the sight of Britain's venal politicians getting their come uppance over fraudulent expense claims.

I mused some time ago that the rise in equities might be down to the huge wave of liquidity that just about all governments are injecting into the system. After all, those billions of taxpayers dollars have got to find a useful home somewhere . Where after the post-Lehman collapse in prices could be better than the equity market ? Just about everyone apart from the shorts benefits. Banking shares soar reducing their huge capital raising requirement . At the same time long only investment houses and pension funds see the damage wrought to their portfolios in 2008 being rapidly repaired. Retail investors are happy that their portfolios are turning to the upside. Indeed, for long only houses taking a five year view equities with low debt levels and strong cash flows probably provide some form of inflation hedge even if the economy is zero growth . Having said that quite why banking and retail is leading the charge escapes me as the latest data still shows weakness:.

April US credit card defaults rose to record highs - Citibanks delinquency rate in April was 10.2%

• US industrial production fell 0.5% in April after the 1.7% fall in March. Shockingly capacity utilization is now 69.1% implying that any investment in facility expansion will be sometime acoming.When factories are producing too many goods pricing power disappears - FIAT take note.
  
• Hotel occupancy levels in the US are approaching levels last seen in 1981 and stand at 53.6% on an average room rate of $97.58 down 14% and 10% respectively from year ago levels.
  
  Taking the above into account it seems to me that :

1) it's too early to get steamed up about inflation with factory utilization running below 70% and stockpiles in steel and other commodities rising . Europe seems to be heading towards deflation with a 2.5% fall in eurozone GDP in Q1 with Germany tumbling 3.5% a worse number than the debt ridden UK's 1.9%. You can criticise the Brits for being overleveraged but it was the Germans and French who sold to them and who are now discovering just how important the anglo-saxon markets were.

2) savings rates are on the rise with the UK lvel going from -1.2% to nearly 5% today. History teaches that these levels will probably come close to doubling over the next two years further weakening consumer demand .

3) Banks and governments are hoping that they will be allowed to repair their balance sheets over a five year period as consumer loans are sliced back and personal savings rates move towards a 10% level in the anglo-saxon world.

4) the world is entering a period of slower and lower growth. In this new world there will be fewer airlines,car makers,banks,insurance companies,and small retail chains.

I'll buy selectively when we get a good setback towards 4000 on the FTSE .

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.