Tuesday, November 27, 2007


The turn around in the airlines came about as a result of strong demand. Strong demand will cure the ailments of most any business. There is a huge contrast between the airline demand story and many other concurrent demand stores. For example, the hand gadget business has seen an explosion of demand but this demand is a result of an abundant supply at ever lower prices.

Take a look at the latest Nokia tablet computer, the N810. This hand held device comes with 2 gigabytes of memory and is expandable to 8 gigabytes with the insertion of a relatively small memory card. The device is more powerful than the computer on my desk at about 20% of the price. It comes ready to communicate through WIFI and Bluetooth. It works well as a VoIP phone, as a music server and as a GPS navigator. The suggested retail price is $479. The price of last years model, the N800 has fallen to around $225 while Amazon offers the N810 for $449. The value of mobility is demonstrated by the number of users at the local Panera Bread or Starbucks.

Gadget makers find a price level that the public will pay and then add as many features at that price will support. A couple of years ago, a one dimensional GPS device sold for $600 or more. Today, the price of the GPS has come down but, one can look at the GPS in the N810 as a gift. It cost nothing because $449 is perceived as a more than fair price for a powerful WIFI mobile computer. Because the price is perceived as more than fair, gadgets are jumping off the shelves. Apple, to sell its share, must stay ahead of the pack. There are many major players, including Google, who are trying to offer the best products at the lowest prices. The demand for gadgets will continue to be strong because the price has fallen to a level that makes the devices great substitutes. Who will buy a paper map after experiencing the benefit of having ones location constantly updated on an electronic map with many other advanced features available.

To make profits selling hand held gadgets, the producers must be among the fastest "guys on the treadmill". The number of devices sold is going to continue to increase rapidly but the only way to keep the price high is to quickly innovate with advanced features. No producer can afford much inventory because the value of the old gadgets collapses as soon as the next vendors wares hit the shelves (cyberspace shelves). Again, the N800 did not start out as a $225 device. The price has been cut in half only because there are better alternative products.

The demand for gadgets has risen due to a sharp decline in the price per gadget but the demand for airline seats has risen despite a sharp increase in the price per seat. This price increase has been repeated many times over the past 4 years. This morning DAL announced yet another fare increase. An increase in demand while new supply is restricted is ideal condition for increased profits. The number of seats being sold has increased while the price per seat has risen. Even the price charged by the deep discounters has generally increased over the past four years. The supply of available seats is relatively fixed. The concurrent rise in demand for oil has increased the cost of the seat but this cost pressure has been offset by a dramatic decrease in the cost of labor. The cost of labor has been reduced by two factors, lower negotiated wages and benefits and a dramatic increase in productivity. Now a days, passengers frequently buy their tickets, check-in and change itineraries at computer kiosk without the participation of airline employees.

Over the past four years, day after day, "TV talking heads" have suggested that the airlines are suffering as a result of high fuel prices. The public has been "trained" that an increase in the price of oil means a decrease in the price of airline stocks. Of course, anyone can take a look at the price of airlines of AMR or CAL and see that the price of the stocks has gone up with the price of oil and one can look at the income statements to see that prior losses have been turned to profits as the price of oil increased.

Today, the airline market faces a couple of big questions. 1) Will the world economy slow to the point that it decreases demand for airline seats enough to cause a reduction in the price of seats? 2) Will the supply of airplanes finally catch up enough to cause the price of seats to decline?

Without question, economic growth in certain industries has slowed. At the same time, broad measures of economic growth such as the GNP of the USA has shown great strength. The growth rate of the last quarter was initially believed to be about 3.8% but it is now expected to be revised to 4.5% or higher. This is real growth after inflation!

The world economy will slow some. However, areas that have slowed are ready to accelerate again.

The big drag on the US economy has been in the area of housing and many predict that it will take a long time before the housing market recovers. However, the cost of houses is greatly influenced by the cost of financing which is falling hard and fast. The 10 years treasury bond traded at 3.8% yesterday. A 1% drop in the mortgage rate reduces the payment on a $500,000 loan by more than $300 per month. Of course, the $300 often is translated into more house, not smaller payments. Suddenly the buyer can afford a $560,000 house for the same payment. In a good market, it is the same house, same payment but the mortgage is $560,000 not $500,000.

The big decline in interest rates is not over. The FOMC and the ECB, to name two, have been dragging their feet. They have had cover to emphasis inflation risk because the price of oil has stayed high. The number one best inflation indicator is the interest rates offered by long term notes and bonds. The recent fall of the 10 year note to 3.8% says that inflation is likely to fall in the coming months. As interest rates fall, the likelihood of a housing rebound increases.

The decline in the price of gadgets and the world boom in airline traffic are part and parcel to the same phenomenon. Yesterday, reporters ran themselves in circles trying to explain the significant increase in shoppers with reports that the average purchase per shopper had declined. For two years in a row, big screen TV's were being carried out of stores at 5 o'clock in the morning on Black Friday. More were being carried out this year but the price per screen had fallen again.

Reporters are also in a tizzy about the massive number of new planes on order. New 40 Billion Dollar orders seem to be coming one right after the other. Reporters tend to ignore the fact that the orders now being placed are for delivery in 2014. The companies ordering billions of dollars of new planes believe that demand is going to continue to soar. If they could get their hands on new planes now, they could fly them profitably. It is going to be 5 years or so before increased capacity results in tight profit margins.


Over the past few weeks, good and bad stocks have been sucked into a black hole. Novice investors will see the lower prices on past leaders and "buy the dips". The turn in leadership is a process. Once the "new bull market" starts, those who have bought into old leaders will not recognize their error until months have passed. In 1982, I bought Deere and Company and rode it for a strong move through the recovery phase of the economic cycle. By the mid 1980's the market fell in love with the stock and bought it heavily during the turn. It under performed for the next several years. Last week, one of the big investment houses put a strong buy rating on Deere. This is the same old story. The stock has done well over the past 5 years. The number of acres of corn planted this past year was at an all time record. The increase in acres planted cannot go up from here. Even the UN is now discouraging the use of food stocks for fuel. It is not time to buy Deere and Company or other "first half stocks".


The markets are now offering the best buying opportunity in a very long time. The average stock is now cheaper than at any time since 1995. Many stocks are in the 1982 cheap range. Opportunity knocks. Add money to your account every month because money added at or near a bottom often doubles again and again on the way up.