:: October 2020 Letter ::
U? V? L? Reclining L? Nike Swoosh? Bathtub? The hot debate this year in world markets is, “Which symbol most resembles the duration of the Covid-19 downturn and the subsequent recovery?” Economics isn’t called the Dismal Science for nothing. Since the pandemic started, I’ve been a U believer, with U representing a deep drop, a relatively long floor, and a steep recovery. But that’s for jetliner output; for air travel, a Reclining L looks accurate.
But now, smart people are telling me I might want to be a K-guy. The letter K illustrates a bifurcated two-track recovery: one line trending up, one line trending down. The big picture folks say this letter represents, for example, a faster recovery (or uninterrupted growth) for wealthier people, while the middle- and lower-income groups lose ground. The K, in that context, represents worsening inequality. K can also represent the Tech sector’s continuing growth relative to the broader economy, which, of course is in much worse shape.
Unfortunately, now that I have the idea in my head, I now see up/down Ks throughout our industry, and in related indicators:
Business Jets over Jetliners. Unsurprisingly, business jet travel has made a strong recovery from its severe decline (just -15% y/y in October), while airline traffic remains down by ~70%. Our business jet forecast now just shows a relatively shallow dip, while our jetliner numbers are tanking. This is a reversal of 2008, when jetliners kept growing while business jet output collapsed. Thanks to this dynamic, Gulfstream recently became the world’s third biggest planemaker, displacing Embraer.
Small/Medium Cabin Bizav over Large Cabin Jets. While Gulfstream output is strong, the rest of the large cabin segment is underperforming the small and medium classes. According to JETNET iQ, Fractional operations (Part 91K) are up 12% Y/Y, while charter cycles (Part 135) are up 6% Y/Y. Part 91 operations (which generally involve larger aircraft than 91K and 135) remain down 32% Y/Y. Also, medium cabin asking prices are down just 7% y/y and light 3.8%, while large cabin asking prices are down 17.4%. This too is the exact opposite of 2008, when larger jets continued to grow and the bottom half of the market disintegrated.
China Over RoW. In contrast with the rest of the world’s 70+% decline, China domestic air travel passenger volume has nearly recovered (to 97.2% of pre-Covid levels). China also reported 4.9% GDP growth in the third quarter compared with last year, a nice recovery from the first quarter’s -6.8%.
International traffic over domestic. The China pattern – domestic traffic recovering faster than international – is showing up worldwide. We’ll see this trend continue for as long as the pandemic keeps borders closed, and since business and leisure travelers won’t be keen on long trips until there’s a vaccine. This pattern will continue to suppress twin aisle demand well after single aisles start to recover, creating another K.
Freight Over Passenger demand (RPKs). Cargo, in relative terms, is in okay shape, down just 8% y/y according to IATA (again, compared with -70% for pax). The pandemic’s persistence, and associated logistical challenges, will further boost cargo in the coming months, particularly when vaccine distribution kicks in.
Military Over Civil. As a result of the pandemic, our combined civil market forecast line now has a terrible trough extending through 2024 (but with a topline recovery slowly starting next year). By contrast, there has been no change at all to our military forecast, which continues to grow at a decent pace (after some pandemic-related production disruptions). There are two interesting consequences. The first is that defense companies need to closely monitor the health of their supply chain, as suppliers fall prey to the civil downturn. Saab’s need to intervene in their Gripen supply chain impacted their most recent quarterly results. The second consequence of this K is that defense firms now have an opportunity to grow their civil market presence, at a discount. We may see a form of arbitrage, with military firms leveraging their relative strength to buy into civil programs or acquire distressed civil assets.
Everything Over Passenger Jetliners. When you add up all the numbers and trends in our coverage universe, it looks like every single aero market segment is either unaffected by Covid-19, or not as affected as we had feared when this damn thing started. Except, that is, for passenger jetliners, which are a dumpster fire. This isn’t much of a silver lining when jetliners are over half of my coverage universe (by value of deliveries) but at least it isolates the problem, and makes it somehow more manageable. Which brings us to the next K….
Wall Street Over Main Street. This K might prop up the jetliner market. In 2008, the broader economy wasn’t that big a problem, but the financial sector almost melted down. Today’s crisis (yet again) is an inversion of that, with equities markets and capital markets doing fine, and the rest of the economy collapsing. The financial sector’s health matters for jetliners because even though people aren’t flying, lessors and other financiers are willing and able to keep financing jets. Orders have collapsed, deliveries are falling fast, but sale and leaseback transactions are holding up. If they keep holding up, then jetliner output rates might not fall further.
Airbus Over Boeing. Airbus this month announced that it might get back to 47 A320 series jet per month. That’s overambitious given the market’s difficulties, but it’s possible, in large part due to the A321neo/LR/XLR. Demand for that jet remains strong, again in relative terms, and Boeing doesn’t really have an effective competitor. This is helping to keep Airbus’s backlog intact while Boeing’s declines. Supported by a secular shift away from twin aisles and towards single aisles for international routes, the A321 will continue to grow Airbus’s market share at Boeing’s expense, until Boeing does something.
I’m not done with this letter metaphor. K also symbolizes the development of an unwelcome rift. For example, economic and political de-coupling between China and the West. Or, the horrible political and societal divisions now seen in the US. To conclude, consider this line from William Butler Yeats’ The Second Coming: Things fall apart; the centre cannot hold.
Yours, ‘Til The Centre Returns and The K Vanishes,
© Richard Aboulafia 1997-2006, All rights reserved.