Sentiment heads south.

Markets seem to be coming round to the view that we are in this for the long haul and that the 'green shoots' are going to grow at a rather leisurely pace rather than at the vigorous rate that so many have been anticipating. When the SPX gets well below 800 I'll start to look at stocks again.

Over dinner a few nights ago a neighbour suddenly launched into an impassioned attack on bankers, greed and the need for much tougher regulation of the financial industry. It suddenly struck me that the call for additional oversight ,although popular, if badly handled might make matters worse- possibly much worse.

Anyone who has ever had to deal with the FSA or SEC over the last decade will know that this economic crisis did not occur because of lack of regulation - these august bodies already had vast armies of people, a record number of regulations,and near unlimited powers. Now , the regulators want even more powers and want the banks to raise more capital,lend less and impose tighter controls.

In a world where credit is evaporating , capex is shrivelling and where factory utilisation numbers are dismal (65% in US manufacturing) this enforced shrinking of capital is the last thing we need.With US and Euroland banks needing to write down another $1 trillion or so over the next couple of years governments are talking about imposing what looks like regulatory and economic idiocy. Why not simply go back to the good old days of partnership structures and unlimited directors responsibility? I'm all for sensible targetted regulation but hastily drafted rules might end up proving to have dire,and unintended consequences for the broader economy.

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.

Consistently wrong.

Having called the market 100% correctly on the way down it's dreadful to admit that I've called it 100% wrong on the way up. While I've been worried about the health of Euroland banks and the massive industrial overcapacity that the US and EU are going to be left with in 2010 others have been focusing on:

• The coherent policy actions taken by government to get the world moving again
• The way second quarter numbers were overly negative and have surprised on the upside
• For the man on the street lower interest and mortgage rates are putting money into his pocket
• With the S&P at 666 levels prices were at all time lows and discounting Armageddon
• Long only funds are long cash and short equities and now having to play catch-up
• Hedge Funds have seen redemptions slow or cease and are back to earning their money by investing
• We're all expecting a correction but the market has a way of surprising us - why shouldn't it go higher?

Cash has proven to be the wrong place to be. Until the bills for the stimulus packages come due through higher tax and structurally slower growth there is no reason for markets not to party.What the hangover will be like when the party finishes is a different question.This is till likely to be the deepest recession since 1945 even if a depression has been averted.

If hotels could talk.....

Am still sitting on cash. The latest airline numbers might point to some slow down in the rate of decline in the global economy but that's as bullish as I can get. As for growth forget it. Aprils IATA data shows the decline in demand continuing (load factors fell to 74.4% despite the boost from the Easter holidays) outstripping the 2.5% cutback in capacity. Premium traffic in March saw a 35-40% drop in revenues. Cargo traffic in April was down a shocking 23.3% from prior year levels.May will be a key month - if there is some tentative sign of inventory restocking then it should show up in the cargo numbers then - if it doesn't some of the airlines are going to be on life support.

Spent Friday night in London. The Berkeley was as always efficient,comfortable and an overall fun place to stay ( like the Carlyle in New York or the Park Hyatt in Milan they somehow manage to find polite,unflappable staff ). The main restaurant was already booked solid when we made the reservation three weeks ago but they called back to say we could have a dinner table at 10.30. We opted for the Box Tree Cafe and a more reasonable time of 9.30. From the look of London on a Friday night there is no sign of a recession, the hotel, restaurant and bars were all humming.Onto Woodstock on Saturday for a wedding. The Feathers had lost our reservation which was no loss as The Bear was an altogether better choice. Again, no sign of a downturn with restaurants and bars all solid.Was struck speechless to see a coachload of Japanese tourists getting off their bus with all of them wearing face masks as a first line of defence against swine flu.

Wedding was full of City grandees many complaining about their new ( vulgar and brain dead ) owners. Feeling over the third glass of Dom was that the rally was running out of steam but that another leg would come storming through when long only funds decided to commit to the market - even hedge funds are seeing a slowdown in the rate of redemptions.It seems the big worry for many institutional investors is that having missed the upwards turn in April they are in danger of underperforming for a second quarter if they don't get their equity weightings back up into line.Absolutely no allowance being made for geopolitical problems re North Korea or Tehran.I seem to be a solitary bear.

The money just keeps on rolling into the market and out of companies

Spoke to my old friend the head of research at a large NY bulge bracket about the markets. His sanguine view is that there is still a lot more upside as the actuaries start to tell institutions that they are underweight equities. In short don't fight the wall of money. We'll see.

US hotel occupancy rates fell to 57.8% down 12.6% from the year earlier period while the average daily room rate was down 10% to $98.33. Not a sector to be investing in just yet.

There are signs that the pace of decline in the global economy is moderating . In Taiwan after a 7.4% fall in Q4 the economy stablized and returned a fall of just 1.5% in Q1 2009. Y-o-y the Taiwanese economy contracted by 10.2% - or to put it another way the biggest recorded fall since 1952 when records began. We should see some signs of growth in the current quarter as Korea,Taiwan and Singapore see some recovery from the 35-50% decline in exports they've suffered. Stock levels around the globe are now at , or approaching a base level and will need to be built up.

Despite these green shoots we are still likely to find that global GDP has contracted by around 7-8% between October 2008 and the end of this quarter. In the US nominal wages have turned negative for the first time in 50 years while the only employer hiring staff was the government - the private sector continues to shed employees.Growth when it comes will be laggardly.

When markets wake up later this year to just how much money corporates and governments are going to need to repair balance sheets and fund spending the fun will begin. I'm still of the opinion that there is more uncertainty coming although this next time it may hit the government debt and currency markets harder. British Airways today announced a full year loss of £401m. That's a £1.3 bn profit reversal during the course of the year. Those low cost carriers are going to start hurting if fuel prices carry on rising north of $60.

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 .

Lufthansa, Air France, Iberia and Aeroflot all feeling the heat

Have just seen the Governor of the Bank of England on Bloomberg. He seems every bit as confused as me. Inflation has 'significant risks in each direction'. Bank capital maybe sufficient - or not. The economy may have troughed and be slowly growing - or not. Doesn't fill me with confidence.The impression I got ( reading my own book ?) was that after the 'massive stimulus' the authorities are still uncertain about the turnaround but are inclined to believe it will be slow and possibly very slow.

If I'm not getting any steer from the powers that be then self reliance in forecasting is the game. The numbers from the airline sector still aren't telling me that the pace of contraction in the economy is letting up. Lufthansa's passenger numbers are down 4.6% in April from year ago levels while cargo volumes are down an eye scorching 26%. Air France-KLM's passenger numbers are down 3.7% while their code share partner Aeroflot has said it plans to amend its 2009 capacity and budget due to falling demand. On top of all this Iberia's management said that they had ' low visibility regarding 2009 full year results' - so no sign of a stabilization there! The hopeful signs that the pace of contraction is slowing simply aren't being seen in business class or discretionary travel within and beyond Europe. The recent hike in oil prices is going to make the business planning for the legacy carriers much more difficult if it is sustained - rising input prices and trough levels of demand make an unholy alliance for any CFO. One airline exec made the comment that although there are some signs that Italy and France might have reached a possible trough in Q1, corporations in the UK are shedding staff at the fastest rate since records began in 1996.