Monday, November 07, 2005



The big investment banks are lining up with buy recommendations on the major airlines. The numbers are compelling which means these guys can no longer ignore them.

The latest convert was Lehman Brothers which has upped its rating on AMR from neutral to overweight. The reasons given were "risk-reward has improved for the airline due to capacity reductions and a muted reaction to recent fuel price declines".

My bet is that crude oil is going to decline to around $55 where it will dance for serveral months to perhaps a year or more before going lower. In the short run, the risk of a strick against Royal Dutch is on the horizon. However, given a little time, refinery capacity increases in South Korea, Vietnam, Quatar, South Africa, Russia, China, Iran and elsewhere (eventually in Iraq) will gradually effect the outlook.

The key point is that the legacy carriers have reduced other costs to the point that profits will rise with each decline in fuel costs. In the mean time, yeild is going up. The yield is going up for one main reason; business travel demand is very high during the expansion phase of the economic cycle.

DAL recently announced that they will install 28 addtional first class seats in 48 of their big planes. Have you checked on the difference in price of a first class ticket and a coach ticket? Of course, the seats are going into the long-haul flights where business professionals are not willing to ride for hours in cramped coach seats. Assuming a net price spread of only $500 per seat and assuming only 5 flights per week for 50 weeks per year and these 1,344 seats should increase DAL's revenues by $160 million dollars per year.

Do not buy DAL! The firm is in bankruptcy and the shares are virtually worthless. On the other hand, CAL and AMR have been making the same type conversions for many months. The story is even bigger than it sounds.

To install 28 first class seats, the airline must take out more coach seats. The space occupied by the first class seats makes more revenue for the airline but a very important point is that the total number of seats available goes down; capacity is reduced. As you might expect, the fare for each of the remaining coach seats goes up because the supply demand equation has been altered.

The market was basically strong all day in Asia today. The market is off to a wonderful start here. Inflation pressures continue to subside. The bond market is trading up as is the Dow, S&P and Nasdaq. Oil is pushing against resistance at $60. What is not to like? Consumers and businesses are spending on productive assets such as cell phones.

I have made the following point before but one seldom sees the point made in the mist of all the gloom and doom reporting so I will make it again. Let's say a fellow has broadband internet, takes the daily paper, two magazines and pays for a standard phone line plus long distance charges. Now lets say, as the information he needs becomes more abundant and more retrievable on the internet that he decides to stop taking the newpaper, one magazine and he switches to a broadband phone with unlimited free long-distance charges.

Investors then look at the Personal Consumption Expediture Deflator, which is the favorite measure of inflation used by the FOMC, and this statistic shows inflation to be very moderate (1.3% was the latest core number). Indeed this particular consumer is living a better life as he has dropped the cost of the newspaper, the magazine and the long distance charges from his "out-go". His personal inflation rate has gone down.

Inflation is like a pac-man eating away at profits, income and GNP. Low inflation is very powerful gas for the stock market (does not hurt bonds either). The current global economy does not allow wages to increase much because technology is facilitating the out sourcing for all kinds of jobs. A recent great example is the tutoring available for school children. The service is provided by teachers from India who speak free of charge over internet phones and review assignments on line. The student and tutor are siting half way around the world from one another but they are talking on the phone and looking at the same web pages.

The bottom line is that we live in a time of productivity growth. The good news is that productivity growth is equal to wealth creation. The reason American's have the highest net worth ever before is that our country allows the market to adjust. We are willing to eliminate GM union jobs if those task can be done at lower cost elsewhere. There are constantly winners and losers in a free society, however, we are all winners in the long run. Those who invest their savings long term in the market are consistently among the "big winners". The average return on long term holdings in the stock market is around 12%. Those who hide their money in money market savings accounts help others get rich but as a group they lose trillions of dollars in opportunity costs.