SHAREMARKETS can work in mysterious ways. The movement in the share prices of Qantas and to a lesser extent its rival Virgin Blue provides a fascinating piece of insight into how investor sentiment on the faintest glimmer of good news will trump fundamentals.

Airlines are the ultimate cyclical business – highly leveraged to strong and weak economic news. Qantas’ share price has been particularly strong over the past few days as the market digested new monthly traffic and capacity statistics that, while representing an improvement, are nothing to get all that excited about.

On the domestic side, there is a pattern beginning to emerge that the airline is regaining some (albeit weak) pricing power. But this is more evident in the low margin leisure business than in the full economy and business class end.

And it’s the business travellers that make this airline the real profit.

Some analysts had been hoping the pick-up would be more pronounced and have felt a little disappointed by the latest Qantas statistics. But the sceptics were generally pleased at any sign of life from the flying kangaroo and have upgraded their numbers slightly.

The troubling news for Qantas is that it is not getting much yield improvement on its international routes. The business traffic remains limited and the talk of shrinking business cabin capacity is a worry.

The fact that yields have bottomed out is clearly a positive sign, but to justify an increase in the share price from here, the market really needs to see some sign that the earnings are taxiing towards lift-off. Half-year result projections suggest the airline is still doing it tough.

The same goes for Virgin Blue. It told its shareholders at the annual meeting that it was no longer expecting a break-even result for the 2010 financial year but would make some profit.

Sadly it did not quantify what this profit might be. Instead it said there were further signs domestic demand was stabilising.

Given that the bulk of Virgin’s business is in the domestic market and its operations are more skewed to leisure, the overall demand uplift we are now seeing should give it better short-term improvements than Qantas will experience.

The other factor that may be feeding into the share prices of our airline industry is the collapse (for a while, at least) of the emissions trading scheme.

The ETS was going to damage airlines probably more than any other industry. While the consensus is that some form of ETS will eventually be approved by Parliament, the timing is less certain and airlines will get some reprieve for now.

Thus any share price gains relating to ETS are probably more about sentiment than reality.

The final ingredient in the mix for airlines is the extent to which these stocks have been a little oversold in the market. The recovery in share prices could just be a bit of catch-up.

But it is fair to say that we should not see any more share price outperformance until there are more tangible signs that international yields are gaining momentum.

EVER since the start of the global financial crisis, Australian banks have begun to engage in a new game – it’s called competition. And as Westpac has learnt this week, it’s a risky business.

Until world credit markets were turned on their heads, we could take comfort in the fact that when the Reserve Bank of Australia adjusted the cash rate, the banks would simply follow suit within a week, adjusting their home lending rates accordingly.

But now they have shown a tendency to disconnect from the RBA and try to claw back some of their increased funding costs by not passing on the full cash rate falls or, as happened this week, by increasing rates further than the RBA. It is now a game of cat and mouse and there is not necessarily any first-mover advantage.

After Tuesday’s RBA decision to increase the cash rate by 25 basis points, Westpac took the plunge and increased its standard variable rate by 45 basis points. It was a political and public relations risk, but financially somewhat justified. Westpac’s cost of borrowings has increased because it gets half of its own borrowings from the still expensive wholesale markets.

Having gone further than the Reserve, the best result for Westpac would have been for the other major banks to ride on its coat-tails.

But National Australia Bank, which has been struggling to retain its share of the mortgage market, saw this as an opportunity to improve its position with the retail market and announced yesterday that it would increase rates by only 25 basis points.

It remains to be seen how this game is played out by ANZ and Commonwealth Bank: the latter felt Treasurer Wayne Swan’s wrath last year when it did not pass on a full RBA rate cut.

Right now the NAB response and lack of response from Commonwealth and ANZ have left Westpac in an unpleasant space.
Source: The Age