Thursday, May 25, 2006


An investor sent the following:"Airline stocks seem to be leaking a lot of oil. I know the market has been soft and I guess there is fear among investors over inflation. Do you think this is a short term weakness in the airlines? Is there any news out there that we have missed or is this just a knee jerk reaction to oil and gas prices?" Yes, there is news. Both the house and the senate have passed pension reform legislation. The two bills have been stalled in the house-senate conference committee for several months. A couple of days ago, Trent Lott tried to break the long jam by threatening to attach the airline portion of the bill to another bill. The house will not go along. The house and "big business" knows pension reform is necessary, however, passing the bill is as tough as taking a dose of Castor oil. The various folks who are against it are holding out for a lot of "sweeteners". The bill as written in the senate would give the legacy airlines an enormous cash flow break. They will ultimately have to set aside all the money required for all pensions but they will have extra years to do so.
The irony is that CAL and AMR are meeting their funding requirements and building up extra cash. With the price of oil dropping off a little, the conference needs to act before it becomes obvious that the big carriers no longer need an extra helping hand. Today's IEA numbers showed that gasoline usage in the US is flat year over year! Usage normally grows by 2 or 3% per year. Airlines have done an even better job of reducing usage than has the public. Airlines are flying 7 to 10% more passengers and using less fuel. One of the things in which I have great confidence is the law of supply and demand. Sometimes it is easy to slip up and say that supply and demand are out of balance. The reality is that supply is always exactly equal to demand at a certain price. Inventories of fuel stored in America are as great as they have ever been. Speculators are hoarding fuel or selling it forward to those who are hedging their costs. Many speculators are refusing to sell what they have in storage at today's price because they have sold it at a higher price in the future or because they think they will sell it at a higher price in the future. The IEA numbers showed again today that the current price is high enough to destroy demand. The countries of the Persian Gulf have cut back production in recent weeks because no one wants to buy all the oil they can produce. When the price finally breaks, oil will be back below $50 in a heartbeat or two.
As far as the over all stock market is concerned, the public is piling into bonds driving up the price while the big increases in stock earnings have made the market all the more relatively cheap. Last week, the smart money confidence indicator jumped from 47% to 58% and the dumb money indicator dropped from around 52% to 47%. I am not a great believer in trying to time the market over the short run but all kinds of indicators show that the market is now over sold. The fearful are running for cover; bargains are available. Aggressive investors will do well if they hang on until the worm turns again. I suspect there will be more rough days ahead in the airline business but who among us can say when the price of oil will break, or who can say what day the house-senate will strike a deal, or who can say when a major gusher will be hit or who can say when Iran will make a deal? On the other hand, who among us was even alive in 1946 which was the last time airlines had such tremendous pricing power?!!