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July 21, 2008

The Airline Sector - Opportunity Cloaked in Crisis...
by Clive Maund

Originally published July 20th, 2008.

The old timers amongst you reading this whose memory hasn't failed will be able to remember when air travel was an enjoyable experience. The "butterflies in the stomach" before each flight were occasioned by awareness of the chance that the aircraft could suddenly plummet to earth and explode in a ball of flames and this gave an edge of excitement to each trip, which was enhanced by the fact that the flights taking off before yours would make the entire Terminal building shake. Planes in the old days were noisy and smoky - you could wave goodbye to loved ones taking off for a long time because they made a long trail of brown smoke, except in Britain where they would rise straight into a leaden overcast.

Partly in order to avoid thinking about the 6 miles or so of air beneath their seats, passengers would strike up conversations and learn interesting things from fellow passengers and many friendships were born - and sometimes people found their partners this way. There were films on a big screen, which although the earpieces made your ears hurt it didn`t really matter because you couldn`t hear much anyway, so many passengers preferred to chat with their neighbours or even look out of the window. Nowadays if you try to strike up a conversation with a fellow passenger you are often regarded as at best a nuisance and a distraction and at worst as an eccentric or even a pervert on the prowl. Everyone sits staring cross-eyed at a postage stamp sized screen at the end of their nose, mounted on the back of the seat in front - you can always tell the first and executive class passengers getting off a long flight because they are the ones with their eyes more parallel, because their screens were twice as far away. In the old days there was something special about going first class but nowadays you find the same slobs in jeans and sneakers sticking their feet all over everything as on the rest of the plane, and the entire plane looks like a disaster area when everyone gets off.

In some respects there is very little to show for 30 years of "progress". Planes go no faster than they did 30 years ago - slower in fact if you consider that the option to go on Concorde no longer exists. Concorde was incredibly noisy and burned a huge amount of fuel, approximately 1 ton per passenger on a flight from London to New York, but that didn`t matter to wealthy folks unconcerned about their carbon footprint - they got where they were going faster and that`s what mattered to them. Despite all the attention to detail that you hear about, aircraft windows are still small, uncomfortable to look out of for a tall person for any period of time, often scratched, dirty and/or misted up or frosted up and never cleaned between flights, exactly as they were 30 years ago - how's that for progress? Even where real progress has been achieved at huge cost - the double beds available on the new Airbus super jumbo, Singapore Airlines had to spoil it by telling couples to "behave themselves" because someone might hear.

The increasing affordability of air travel for the masses over the years has led to massive growth in passenger numbers that has led to airports becoming like cities, and the sheer volume of passengers has resulted in an inevitable decline in service, but it was the events of September 11th 2001 that provided the perfect excuse for bureaucrats and busybodies to make air travellers' lives a misery, particularly in the United States. In the old days you could almost take a machine gun on board as hand luggage, provided it wasn't loaded. Now you have to put up with long lines, take your shoes off and have strange men wearing plastic gloves picking their way through your luggage, in addition to photos, fingerprinting and intimate searches. In the US millions or more probably billions of passenger hours are wasted annually by all this, when the reality is that you are more likely to be struck by lightning than caught up in a terrorist incident. There is a more sinister aspect to these supposedly necessary security measures, which is that this kind of treatment is a way of training people for total submission to the power of the State.

After the body blow of 9/11 many US airlines resorted to extreme measures to stay in business, such as getting rid of food on flights, and making passengers pay for basic snacks. Now, with the price of aviation fuel having rocketed, airlines are again resorting to extreme measures to stay afloat, such as making passengers pay for all luggage, but this is just picking at the problem. The writer has a radical plan that would instantly make all airlines hugely profitable. Using the typical subway train for inspiration, simply rip out all the seats and have passengers stand up holding on to straps. The turnaround time at airports would in addition be greatly reduced by this measure, as cleaning the aircraft would take next to no time. The safety blurb at the start of the flight could be adapted to instructing people to lean forward at an angle of about 25 degress when the plane takes off. This plan would enable airlines to herd probably 3 times as many people into the space currently being occupied by seated passengers. This would be a great way for many people to reduce their carbon footprint.

The patience of many seasoned travellers is wearing very thin, who already have enough to put up with the indignity and inconvenience of the security and searches, but what may be the last straw for them is the prospect of passengers being allowed to use mobile phones on planes, plans for which are apparently advanced. Imagine the prospect of being stuck next to some garrulous, loud-mouthed individual for 10 on 12 hours on a long haul flight with them rabbiting on endlessly, with the additional frustration that you are only hearing half, or perhaps three-quarters of the conversation. You won`t even be able to escape and pay a visit to the Captain and crew up front, as you used to be able to do on occasion - try it and you'll end up being welcomed at your destination in handcuffs.

Just when many airlines were starting to get back on their feet the price of oil and therefore of aviation fuel rocketed. Jet fuel now accounts for 50% of most airlines operating costs and the huge rise of the past year is threatening to bankrupt many airlines and some have already gone under. The fierce competitiveness of the industry makes it impossible to fully pass on the increase in costs, and even if they could they would only succeed in reducing demand for services which would have the same negative result. As oil prices rose to new highs just a couple of weeks ago and consumers, battered by inflation, job losses, falling house prices and a falling stockmarket, are increasingly trimming their sails, things could not look worse for the airline industry, whose stock prices have been plunging for months. Yet, it is just at times of crisis, when things are at their bleakest, that opportunity is to be found, and this is especially the case with stocks, which tend to discount future events 6 to 9 months down the road.

Airline stocks have been hit by a double whammy - they have have dragged lower, as have many sectors, by the severe drop in the broad stockmarket in recent months, and in addition they have been battered by the huge rise in the cost of oil over the past year and therefore of aviation fuel, and as a result they are at valuations which suggest that people are not going to be flying in aircraft for much longer. However, as we know, despite the government`s attempts to make flying as unpleasant as possible, there is limitless pent up demand for it. This is because, when people have the resources to do so, they like to go places, and they much prefer to go on a plane rather than by bus, car, boat or train, because it is about 10 times faster. Thus, unless the world reverts to a primitive Mad Max scenario, which, incidentally, the Federal Reserve has been working assiduously for many years to bring about, people are going to go on flying until there is no more fuel to do so - and even if the world is heading in this direction, it is unlikely to get there in a straight line. It is true that the parlous state of the US economy which has been and is being destroyed by excessive debt, mismanagement and profligacy has actually brought about a drop in air travel in the US, exacerbated by the trend to poor or near non-existent service on US aircraft and excessive security. However, all of this is thought to have been fully discounted and more by the collapse in airline stocks.

The same two factors which have trashed airline stocks in recent months now look set to result in strong gains in the near future. The broad stockmarket had become more and more deeply oversold and reached a nadir of pessimism about a week ago when Fannie and Freddie finally went down the plugpole and had to be rescued by the government, which means the hapless taxpayer picking up the tab - again. This was followed by a strong rally that is expected to mark the start of a "relief rally" that could continue for some months before the market rolls over again and possibly crashes in the Fall, as the problems aren't going away or even being dealt with, and continue to fester in the background. At the same time oil broke down from its long uptrend, an event predicted in the last Oil Market update and which we capitalised on by buying the Proshares Ultrashort Oil & Gas ETF the week before. Oil, which still has something like a $30 premium built into the price on the expectation by speculators that Bush will attack Iran before the election, could of course lose that much if he doesn't. This would provide another boost to airline stocks, which should also benefit from the draconian cost cutting measures now being implemented, even if passengers don't.

We will now take a look at the S&P500 chart with the aim of delineating the possible extent and duration of the likely relief rally, as this, combined with the price of oil falling during the same period, will be the window of opportunity in which it should be possible to net good gains in airline stocks, some of which "broke out" last week, as they rally in response to both of these factors and in response to their own cost cutting measures, and possibly also as a result of buyouts and mergers etc. On the 3-year chart for the $&P500 we can see the index just starting to rally from a deeply oversold trough when pessimism climaxed with the collapse of Fannie and Freddie, followed by relief when the government stepped in to bail them out. Owing to the oversold extreme just reached and the time of year, we are likely to see a continuation of the rally, perhaps for 6 to 8 weeks or so as shown, before reality and the seasonal pessimism of the Fall assert themselves and drive it back down again, with a crash then being a real possibility.

Bearing in mind the extensive crony connections between the US Republican party and the oil industry, we should not be at all surprised at the huge rise in the price of oil, particularly over the past 6 months when the war drums have been beating steadily in the background in respect to Iran, although it would be unfair and inaccurate to blame all of the rise on this. However, with the US elections looming in the Fall, the time has come to chummy up to voters again by suddenly tanking the oil price in the hope that this will help get the old guy elected to The White House - so suddenly talking with Iran is a good way to start the ball rolling. Let's see if it works - the trouble is that voters have an axe to grind over many things right now, not least of which is the plunging value of their homes, so maybe they won't get away with it this time - no matter, they control Obama too so they`re in a win-win situation.

On the 1-year chart for Light Crude we can see last week's breakdown from the uptrend in force from last February and how the current very large gap between the 50 and 200-day moving averages could easily lead to a steep drop back towards the 200-day moving average, as the $30 - $40 "war premium" that was in the price rapidly unwinds.

On the Dow Jones US Airlines Index 1-year chart we can see how it last week broke out of a steep downtrend on strong momentum, and it was no coincidence that this happened at the point when oil broke down from its uptrend. While this does not look like some "flash in the pan" rally to be followed by a drop to new lows, the strength of this breakout drive has rapidly created a short-term overbought condition, so we may see some softening next week before the advance resumes, which would provide a buying opportunity. The prospect now is for a rally which serves to close up the current large gap with the 200-day moving average.

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Clive Maund,
CliveMaund.com

The above represents the opinion and analysis of Mr. Maund, based on data available to him, at the time of writing. Mr. Maunds opinions are his own, and are not a recommendation or an offer to buy or sell securities. No responsibility can be accepted for losses that may result as a consequence of trading on the basis of this analysis.

Mr. Maund is an independent analyst who receives no compensation of any kind from any groups, individuals or corporations mentioned in his reports. As trading and investing in any financial markets may involve serious risk of loss, Mr. Maund recommends that you consult with a qualified investment advisor, one licensed by appropriate regulatory agencies in your legal jurisdiction and do your own due diligence and research when making any kind of a transaction with financial ramifications.

Copyright © 2004-2008 CliveMaund.com All Rights Reserved.

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