Thursday, January 31, 2008


A funny thing happened during the recession of 1991. The housing market gathered strength. By the time the recession was over, housing was on a roll. A few years after the recession, the housing market soared. Since 2005, we have witnessed the "bursting" of the housing bubble. Those who rode the housing market up from 2001 through 2005 did very well. I wonder what the next bubble will be?

The mid cycle correction has flirted with becoming a recession. During this down turn, the economically sensitive airline business has held up well. For example, in the month of January 2008, CAL flew almost 1% more full seats than last year and, if memory serves, last year was the best January on record. The seats were extra full even though fares were increased several times during the year.

The majors have started 2008 with one of the biggest fare increases ever. When a business raises fares and continues to sell more product, one knows that demand for the product is strong. Each of the major airlines now has more cash than market cap. If they each could reach an agreement with their share holders, they could buy all the shares for more money than the current market price. Or, they could buy one another and pay cash.

The expectation has been that DAL will merge with NWA or UAUA and CAL will merge with the one left standing. The expectation has been that the cash on the books of both companies will be preserved while the buyouts are treated as a merger of equals.

Yesterday, after a couple of years of trying, the Midwest Airlines merger was approved. NWA picket up a 47% share and the right to buy the rest under certain conditions. This was a small potatoes deal relative to a DAL -xyz merger but the important point is that the antitrust lawyers let the deal happen. Did this give a green light to other consolidation?

The answer to the last question really does not matter. The airlines have already been permitted to link up into international alliances. The major carriers in effect have partners within the USA and around the rest of the world.

We all know that the world went global gradually over the past 25 years and that the global trend is accelerating. The big airline traffic growth is from under developed nation to developed nation. Places like Nigeria are where new airports are being built. While many of these countries support regional and state owned airlines, they cannot win permission to fly to the developed world without "sharing the traffic". The fast growth in traffic out of Asia, Africa and Eastern Europe is translating into fast growth for companies like CAL, DAL, NWA, UAUA and AMR.

I believe the airlines are in position to be the next "bubble". The bubble of the late 1990's brought great profits to all sorts of companies that provided computers, the connection of computers to networks and communication companies. The growth in these areas will not disappear but the competition is as fierce as ever. What these companies have done is to make it all the more possible to use the human capital that has heretofore wasted away in poverty stricken countries. China has been the lead story in this regard. Twenty five years ago, China had about 800 million people who survived off of about $1 of income per day. Today, there are still 180 million Chinese who survive off the same real amount. What a blessing it has been for Americans, Europeans and others to have received the benefit of low cost products while helping to bring more than 500 million Chinese out of poverty.

The good news is that "The End is Not Nigh" (as written by GaveKal Research). The speed of communication between the US and places such as Nigeria are about to move from fast to super speed. Google is one company that has funded a massive new under water connection. The increased speed of communication will bring all the more people out of poverty and into the world economy. Peace and prosperity "trade together". I do not know the correlation coefficient but the world has witnessed the joint break out of prosperity and peace any number of times.

Kids growing up in the poorest of villages in Africa today will become world travelers. Over the next decade, millions university courses will be delivered over the Internet. Millions of people will speak English and their native language well and millions will feel a connection to the USA. A large number of the best and the brightest will come to America to work and to live. No matter who is elected President of the USA, one of the top priorities will be to reform our broken immigration system. Some will continue to resist any reasonable compromise and they will ask why we need people to come here? It is so easy to forget that America would be nothing if it were not for immigration. It is easy to imagine a very different world if Eisenstein and millions of other brilliant people had stayed home.

The bottom line is that the global economy is alive and well. Dramatic growth in US exports has given America a shot in the arm. Now that we are in the prosperity phase of the business cycle, the export bubble is being inflated.

The next bubble is an export bubble of US designed goods and services. The airlines will participate in this bubble and indeed enjoy one of their own.

The massive cut in the Fed Funds Rate of from 4.25% to 3% in the past 10 days will take a couple of months to show up in economic growth. Since the yield curve is now positive, for the first time in 19 months, banks can afford to lend again. Late yesterday, the senate finance committee retreated from the most ridiculous of their tax rebate schemes. The package that left the committee is not all that different from the house bill. Clearly, the congress wants to get this bill passed in time to take credit for the economic up turn. If the full senate passes this bill, there will be some noise out of the house-senate conference committee for a few days but the final bill should be passed quickly. Once done, the cooperating news media will interview congressional leaders who will be eager to tell how the economy is likely to bounce as a result of their brave, yes even courageous, actions. The market sentiment is ready to bounce. Much of the uncertainty of the nomination process is almost over. Pretty soon, we are likely to know that the candidates are McCain and Hillary. Both democrats and republicans are currently concerned about the deep fissures in each party. Rush and other boisterous right wingers will fuss long and loud until the smoke clears between Hillary and Obama. Once the democratic decision has been made, the right wingers will coalesce behind McCain. There is a good chance that Huckabee will be the republican VP nominee which would bring a large portion of the social conservatives into the McCain camp.

Of course, anything can happen in politics. As we know, early in the year, McCain gave up his commanding lead to Rudy and Hillary's coronation took a very long detour. In recent days, the republican establishment has rallied around McCain while the democratic establishment has splintered. No matter, Hillary is still the odds on candidate of the democrats.

McCain, assuming the right wingers come out to vote against Hillary (or Obama), represents a difficult challenge for the democrats. He polls very well with independents. He also wins handily among those who believe in peace through military strength. He clearly deserves credit for the success of the surge in Iraq. With the prospects of a major economic revival, lower oil prices and good political and military news out of the Middle East, McCain is a slight favorite to beat Hillary. Though Obama has skills, I suspect that McCain would ultimately beat Obama by a significant margin. Even democrats have recently seen that a black man cannot yet expect to win a majority of white votes in many communities. Obama would bring out the black vote but no matter what we may wish, he would also bring out the anti black vote.


An analyst has upgraded his UAUA earnings estimate and given "back door support" for the potential for merger. He reports that labor relations have "calmed down". It must have been 15 years or more ago when UAUA unions won operating control of the company. The lesson is that even a monopoly loses when it tries to force its will on others.

On economic weakness, oil prices are down a couple of dollars per barrel today. CAL is up more than a $1. The airlines are gradually climbing even in the face of the economic slow down. They will do very well when the slowdown is over. So well that the pundits who have bashed the airline business for many years will talk about the "airline bubble".