:: November 2019 Letter ::
Not to be alarmist, but our planet may have moved to a part of the universe where cause and effect have been de-linked. The commercial aviation industry this year has been acting very strangely, and I’m struggling for explanations. The usual order of events has come undone.
A brief primer on jetliner forecasting: First, economic growth, as measured in GDP, does something, moving up or down. Predictably, air travel demand, as measured in RPKs (revenue passenger kilometers), then does something corresponding to GDP. Airline profits rise or fall. Jetliner orders then rise or fall. Jetliner output usually, but not always, follows orders (the one exception is after 2008, when jetliner production became the only healthy part of the world economy, even though traffic and orders collapsed).
What’s happening today is weirder than 2008. GDP is fine. There are economic slowdowns here and there, but no clear indicators of a recession in any major region of the world. But earlier this year, air travel demand growth suddenly spiked downward. After a decade of above trend growth, peaking at 7.6% year/year in 2017 and 6.5% last year (IATA numbers), we saw a serious downshift, from 6.5% in January and 5.3% in February, to just 3.1% in March. The year since has hovered just above that, with an anemic 3.4% in October. IATA’s latest forecast calls for just 4.2% growth this year and 4.1% in 2020.
If we aren’t suffering from a cause-effect disruption in the universe, what are the possible reasons for the alarming slowdown? There’s Greta Thunberg telling people not to fly, but the epicenter of this downshift is Asia, the World’s Least Eco-Conscious Continent. There must be something else at work. Here’s my list:
1. Trade decline. The world continues to de-globalize, with new trade barriers and trade wars popping up like highway speed bumps. Air cargo demand this year is suffering far worse than passenger traffic, with the worst numbers since 2009 (-4.5% in September, -3.5% in October, and this is early peak season). Trade plays a supporting role (to GDP) in jetliner forecasts, but it’s usually just a long-term role, not an explanation for why people are suddenly spending less of their wealth on flying. Still, business travel demand is suffering from this trade falloff.
2. Capacity Constraints. Some have opined that jetliner and infrastructure problems are a big part of the traffic drop. Capacity may be a a factor, but a relatively small one, like 0.5% or 1% at most, and not the 3+% drop we’ve seen. It’s also an explanation for short-term market behavior, and it ceases to be an issue if IATA is right about 2020.
3. It’s a leading indicator. The air travel growth downturn might presage an economic downturn, a canary-in-a-coal-mine thing. But again, it’s usually the other way around. Besides, consumer spending is reasonably strong; they just aren’t spending it on air travel.
4. Generic market behavior. Analysts use terms like “correction” or “cycle” or “reversion to the mean” to explain what’s going on. While worth thinking about, “cyclicality” typically refers to markets for things, where you see a buildup of supply, which gets ahead of demand. But air travel is a service. Demand may correspond to something cyclical, like the broader economy, but I can’t see how a service, de-linked to that broader demand driver, can be cyclical. Consumption of high-end restaurant meals, for example, is not cyclical, and people would regard it as very weird if demand for tasty meals fell off during a time of economic prosperity. And markets usually do revert to the mean, but that certainly doesn’t mean their growth rates suddenly get cut in half.
5. China. This is the biggest problem. Last October, China domestic traffic grew 12.2%, and most of the past few decades have seen this kind of double-digit growth. But this October it was 5.3%. Either the usual multiplier between GDP and air travel has broken for some reason, or, as many economists opine, the PRC government is simply fabricating its GDP numbers. With this latter, likelier explanation, real China GDP growth is 2-3%, not the 6% they claim.
This fifth explanation, China, is responsible for a lot of the slowdown. But here’s the monkey wrench: the broader Asia Pacific is a problem too. Demand growth there fell to 3.6% in October from 7.6% last October. Some of this is China, but much of it isn’t. These countries’ economic growth numbers are much more transparent than China’s, and there’s no recession, so here it seems there’s an unfortunate explanation at work: the relationship between wealth and air travel propensity has taken a hit. It may be a short-term phenomenon, but the consequences are serious. The likeliest explanation here is the first one: the decline in world trade.
This traffic question is crucial to the jetliner industry. As a very rough guide, for each point of traffic growth lost in a given year, demand for new or existing jets falls by about 200 average sized jetliners. That means, theoretically, we either need 500 fewer deliveries next year, or 500 more retirements, or a mix.
In the short run, the market is insulated from this downward pressure by high airline profits ($25.9 billion this year, also per IATA), large jetliner backlogs, and of course sheer production inertia. Then again, if fuel falls to $40/bbl while traffic stays low, all those thousands of backlogged next generation single aisles look much less appealing.
If fuel drops and traffic growth stays dismal, we’ll see a seriously painful bust cycle. There’d be record high Airbus and Boeing single aisle production rates just as the industry was simultaneously digesting 387 re-delivered 737MAXs (we presume) and another 400-500 MAXs that have been built but not delivered. So, there’d be a capacity avalanche exactly when airlines really didn’t want it. This situation likely plays a big role in Boeing’s thinking about maintaining MAX production at 42 per month – these jets get added to the enormous pile of aircraft arriving right in the middle of a sluggish market.
Let’s hope for the universe to be put right in terms of traffic growth, and for $55+/bbl fuel. Otherwise, we’ll be set up for a seriously bad 2021.
Yours, ‘Til The Universe Behaves Right Again,
© Richard Aboulafia 1997-2006, All rights reserved.