What Airlines Can Teach The Energy Sector About Adversity by Frank Holmes
If you’ve studied psychology, and specifically behavioral finance, you might be familiar with the concept of adversity quotient (AQ), which measures how well someone is able to face and cope with, well, adversity. It looks at how we use the tools given to us in order to survive and recover from setbacks.
To get a better idea of AQ, picture two soldiers who have recently returned home from war. Both are jaded, shaken and physically and emotionally scarred. And yet only one of them truly manages to cope with what he did and saw on the field of battle. He attends school, obtains a degree, gets married and becomes a loving husband and father. Maybe he even starts his own business.
Tiger Legatus Master Fund was up 0.1% net for the second quarter, compared to the MSCI World Index's 7.9% return and the S&P 500's 8.5% gain. For the first half of the year, Tiger Legatus is up 9%, while the MSCI World Index has gained 13.3%, and the S&P has returned 15.3%. Q2 2021 hedge Read More
Keeping in mind that there are numerous factors outside our control, both internal and external, it’s constructive to consider what steps could be taken in this hypothetical scenario to confront adversity and not only survive but thrive. Why was one soldier more successful than the other?
The same question can be applied to companies facing adversity. Right now, many companies have to deal with one of the worst commodities bear markets in recent memory and an overbearing U.S. dollar, among other challenges.
When the greenback gains in strength, it squeezes the value of overseas sales and hurts exports. The dollar is up 20 percent for the one-year period, compared to the S&P 500 Index, up around 9 percent.
Like the soldier with the higher adversity quotient, some companies and industries are more nimble and better able at thriving in different climates, even one as challenging as now.
Record Earnings Season for Domestic Airlines
Domestic airlines, for instance, posted their first-ever $5 billion in net quarterly profits, with the four industry leaders alone generating a combined $4.99 billion, according to aviation reporter Terry Maxon of the Dallas Morning News. It’s now estimated that carriers will manage to beat this amount in the third quarter by as much as $1 billion.
Not bad for an industry that only 10 years ago was mired in plunging margins and multiple bankruptcies.
Investment analysts are taking note. In a recent report, S&P Capital IQ writes that, although several airlines’ stock prices have declined this year, “airline execs have learned from past costly mistakes on adding too much capacity.” The financial information provider “forecasts 2015 as a record profitability year, driven by revenue growth and the benefits of lower oil prices.”
Airlines have managed to stay ahead, but other industries haven’t fared as well. Once all companies have reported this quarter, we might end up seeing the first decline in bottom-line earnings since the third quarter of 2012. And for the first time since the second and third quarters of 2009, we might have two back-to-back declines in revenue. According to the Financial Times, 10 of the largest multinational American companies, including Apple, General Motors, IBM and Amazon, have seen sales revenue drop a combined $31 billion so far this year.
Because of the greenback’s strength, real imports are outstripping real exports, leading to a decline in net exports.
The spread between the two might very well widen, or at least hold steady, in the coming weeks and months. Many central banks began to loosen monetary policies around the same time that the Federal Reserve ended its own quantitative easing program back in October. It’s now seriously considering raising interest rates at a time when other banks have lowered them. From a monetary policy standpoint, the growing divergence between the U.S. and the rest of the world could contribute to the dollar’s continued appreciation against other world currencies.
These so-called “currency wars” are part of the reason why equities in Europe and Japan, both of which slashed rates in 2014, are outperforming the American market for the one-year period.
Low Oil Prices Dragging Down Energy Companies
The sector whose earnings growth has been affected the most by the strong dollar is energy, which dropped 57 percent year-over-year in the second quarter. Oil, priced in dollars internationally, has lost more than half its value in the past 12 months and has taken many energy companies down with it.
As I write this, West Texas Intermediate crude sits at about $44 per barrel, the lowest it’s been since March. For the one-year period, a combined $1.3 trillion has been wiped out from the valuation of companies listed in the MSCI World Energy Index. Some of the worst-performing stocks in the S&P 500 Index for the one-year period are energy-related: Southwestern Energy is down 56 percent; Consol Energy, 65 percent; Ensco, 69 percent; and Chesapeake Energy, 70 percent.
What will these energy companies do to survive this huge commodities downturn? What’s their AQ? Remember, 70 percent of U.S. airlines were operating under Chapter 11 bankruptcy protection between 2005 and 2008. Today, they’re posting record earnings. They managed to turn things around through consolidation and by restructuring their business models.
Energy companies might need to do the same in the meantime as we wait for oil and other commodities to recover.