Outlook: Eddington pulls British Airways out of nosedive

Stuck in a rut; Tesco arrogance  
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The Independent Online

British Airways is discovering what its low-cost rivals have known all along – that if you sell an airline seat cheaply enough, you will always find a bum to fill it, even in these security conscious days. BA's traffic figures have recovered more quickly than anyone dared hope after the 11 September attacks. In December, they were down by just 10 per cent on the year before.

But the improvement has been very largely due to "promotional activity" as BA euphemistically puts it. As a consequence revenue in the last quarter was probably down by half a billion pounds or so and yields have been slashed to the bone. Airlines are experts at establishing what the market clearing price of a seat is. Making money out of the passenger is the harder part. And it gets harder still when the recovery in traffic is driven largely by backpackers flying in the rear of the cabin at bargain-basement prices.

These are the sort of customers that BA was supposed to have jettisoned as it became a business-class, long-haul airline catering for expense account executives who don't mind paying £4,000 to cross the Atlantic and back. Still, the market doesn't seem to mind too much, judging by the 22 per cent rise in BA shares since the start of the year, and it would be churlish to complain. What BA's traffic figures and, to an even greater extent, those of its low-cost competitors demonstrate is that it is really only the Americans who have been deterred from flying to any serious degree.

Furthermore, BA is at least generating desperately needed cashflow. In the immediate aftermath of the terror attacks it was burning cash at the rate of £2m a day. The burn rate has slowed to the point where BA probably does not have to conduct a fire sale of assets to keep itself in the air. But a £1bn rights issue to recapitalise the business is still a real prospect. If BA could combine that with approval for its long-awaited American Airlines alliance and a strategy which tackles its loss-making short-haul business once and for all, its beleaguered shareholders may yet have something to be pleased about.

Stuck in a rut

The time for new year predictions is over, but no apology is made for returning to a favourite theme for this column – that the great bull market of the 1980s and 1990s is over and that equities are in for a prolonged period of low or even negative rates of return. This might seem like a statement of the obvious after the savaging shares have received in the last two years, but it is not a view held by most stock market pundits, where the general belief is that with some sort of economic recovery pretty much assured this year, the bull market will resume.

Not according to Donald Straszheim, a former chief economist at Merrill Lynch who now runs his own boutique, Straszheim Global Advisors. Recent value destruction has undermined the assumption that stock markets only ever go up, but even so the belief that any setback is just another buying opportunity remains largely intact. That's been the experience of the last 20 years, so it's understandable. But it may no longer be safe and certainly it hasn't always been so.

Using the Dow Jones Industrial Average as the benchmark, Mr Straszheim points out that equities went nowhere between 1966 and 1982. 1966 was the first time the Dow broke through the 1,000 barrier and, with various ups and downs, it was still at 1,000 14 years later. The parallels with March 1999, when the Dow first broke through 10,000, are hard to ignore. For nearly three years now, the Dow has gone sideways. Could we be in for another 10 years of the same? Mr Straszheim believes we might be.

With the benefit of hindsight, it's easy to see why equities didn't go up in the 1970s. This was the period of the great oil shocks, double-digit inflation, high interest rates and industrial unrest. As a result corporate earnings struggled to make headway. Dividends were cut and, to the extent that there was any economic growth, all its benefits were gobbled up by the labour force.

The factors depressing stock markets today are very different, but then history hardly ever repeats itself exactly, and the symptoms are much the same – it's proving hard to keep corporate profits rising. High interest rates and high costs aren't the problem this time.

Rather it's low rates of return all round, which in turn is leading business to question the value of investment. According to the textbooks, very low interest rates ought eventually to correct the problem, and most forecasters expect some sort of a rebound in corporate earnings this year, albeit from depressed levels. But it might be unwise to count on it.

We have entered an age of price transparency and unprecedented cross-border competition. In a perfect market, profit may not be a natural state for business, since it is likely constantly to be competed away, and if businesses cannot make profits, then they won't invest. The long-term consequences of these changes are far from clear, but it may be that the balance of economic power is shifting away from capital once more and towards labour. The exploiter is becoming the exploited.

None of this means that stock market investment is dead. There will always be well managed businesses with a competitive edge where the returns are good. But simply buying the index on the dips, an approach that has served investors well for nearly 20 years, may no longer work.

Tesco arrogance

Christmas has proved a mixed bag for Terry Leahy, Tesco's chief executive. The softly spoken Liverpudlian was knighted in the New Year's honours list for services to food retailing. But just days later he finds himself staring down the barrel of a farmer's shotgun.

A group of angry farmers are threatening action against Tesco, claiming that the supermarket giant isn't giving food producers a decent deal. Militant Farmers for Action says it will blockade Tesco's five main national distribution centres if Mr Leahy does not agree to meet and discuss grievances by 8 January.

Tesco regards the threat as not much better than blackmail and is refusing to budge. All the farmers may achieve in the end is publicity, but the situation also has the potential to go badly wrong for Tesco, which has an excellent reputation in most respects and generally enjoys great PR.

Other supermarket groups have adopted a more conciliatory approach. They have met farmers representatives and agreed to pay better prices for some products, but Tesco has stuck by the line that there is a market price for everything and that's what it pays.

Fair enough, but is not Mr Leahy in danger of being overly arrogant? Tesco is so far ahead in the supermarket battle that it has the power to push suppliers around. By some accounts it does just that. Where Tesco enjoys local monopolies there is anecdotal evidence that service levels are not what they are elsewhere.

All this is precisely the kind of criticism levelled at Sainsbury's when it was top of the pile. Let's hope that Mr Leahy, now that he's finally been awarded his gong, isn't about to fall into the same trap.

j.warner@independent.co.uk

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