Back In The Real Economy, A Lot Of Things Are Still Flying

Sydney Morning Herald

Friday August 17, 2007

Elizabeth Knight

ROBERT ELSTONE, who heads the Australian stock exchange and the futures exchange, has a particularly difficult and important job at the moment. He needs to ensure some kind of orderly trading in a panicked market. Yesterday's computer hardware glitch that halted trading in the futures market at a point when the equities market was in free-fall was quintessential bad timing.

Large portfolio managers that needed to cover short positions through the use of the derivatives market were badly caught out. They were forced to sell physical shares. The result was a 3 per cent fall in the market in the space of an hour. It was near impossible to take one's eyes off the screen in the same way as one would watch a train wreck.

There was also talk Merrill Lynch mistakenly issued a sell rather than a buy order and had to rectify the deal later in the day and that this contributed to the massive fall in the market and its equally quick recovery.

In the couple of hours that this took place the market became awash with rumours that another stockbroker was unable to meet margins calls and was going out of business. All of this is the kind of stuff that gets circulated in times of extreme excitement - financial anxiety coupled with an inability to do anything but watch the carnage.

Meanwhile, back in the real world Qantas boss, Geoff Dixon, was delivering to the market a full-year profit that was nearly 54 per cent up on last year. Dixon and his management team have been sowing the seeds for this type of gain for years with vigilant cost-cutting. But the real bonus that enabled this result and allowed Dixon to predict a 30 per cent improvement next year was a robust global economy.

Dixon reckons the booming economies of China, India and Russia means demand for air travel is so strong that aircraft manufacturers can't produce enough new planes to keep up with demands for increased capacity.

There is now a capacity shortage worldwide that has led to increased fares, load factors and yields. Good airlines around the world, thanks to the fact that they have not experienced any external shocks over the past couple of years like terrorist attacks or SARS, have been able to capitalise on the good times.

During the past couple of years airlines like Qantas have also been working hard on their costs - the best of which have been migrating business from their full-service, high-cost businesses to lower-cost budget airlines like Jetstar.

The combination of these factors led Dixon to make the pretty big statement yesterday that the cyclicality of the airline industry has been significantly reduced.

So how does the statement fit with the current chaos in equity markets? The answer is that it doesn't. There is a serious disconnect between what is going on in world equity markets and the world economy and this is recognised by most strategists and economists.

This is why the most common question asked by investors these days is not when should I sell, but rather when should I buy? Those that need to sell are already doing so. Those that can afford to wait are trying to pick the bargains at the bottom of this rout.

The debt binge is over and the equity bubble has burst along with it. But regardless of what pessimists say, the underlying economy remains pretty strong and corporate profitability is testament to this. Profits in the US and Australia released over the past week have been robust and Qantas is but one example.

The Commonwealth Bank result, the Wesfarmers profit and Qantas are but three examples that demonstrate the economy is fine, consumer confidence and demand is high and there is limited financial distress.

But given the disconnect between the debt/equity markets and the real economy, this information is not enough to make any kind of sensible prediction about when this nervousness will abate.

History has clearly demonstrated that excesses must ultimately be moderated. In Australia, which is normally something of a haven for equity market gyrations, we have already seen falls of 12 per cent from mid-July highs. Maybe the same globalisation issue that is a bonus for Qantas is playing havoc with our equities market.

© 2007 Sydney Morning Herald

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