Churchouse Letter
February 2016         by Peter Churchouse

Attention… Brace… Brace…

The last words you want to hear on an airplane... the markets aren't saying this just yet, but the fasten seat belt sign is on...

We share the incredible story of 2 heroes who you've probably never heard of, and how they set the perfect example of how we should approach investing.
We provide a disaster hedge and another defensive recommendation and we continue to prepare for more downside.
“Ladies and gentlemen, this is the Captain speaking. As you are probably aware, we have a small problem with our engines …”

On Saturday 3rd April 2010, Cathay Pacific flight CX780 departed Indonesia’s Surabaya Juanda International Airport with 309 passengers and 13 crew on board bound for Hong Kong.

During the ascent, the Airbus A330-342 pilots noticed minor pressure fluctuations in the right engine (engine 2). There were also fluctuations in the left engine (engine 1), but within a narrower range.

As the plane levelled off at 39,000 feet, 30 minutes into the flight, a system fault flashed up on engine 2. Following procedure they radioed Cathay’s engineers in Hong Kong who advised it was safe to continue given all other engine parameters remained normal.

The same warning flashed up 78 minutes later. Again, the crew contacted Cathay’s engineers to be told it was still safe to continue given all other engine parameters remained normal.

Just over 100 nautical miles southeast of Hong Kong, the situation deteriorated rapidly. Engine 2 stalled completely.

The pilots responded by setting engine 1 to maximum thrust. They radioed the tower for a priority landing.

No need to panic. Like the majority of twin-engine passenger airliners, the Airbus A330 can fly on a single engine.

Then the unthinkable happened. At an altitude of just 8,000 feet and less than 50 miles from Hong Kong, the other engine stalled.

They had lost power in both engines. And they had absolutely no idea why.

Worryingly, this can happen. Last May a Singapore Airlines A330-343 lost power in both engines while cruising at 40,000 feet. The pilots managed to restart the engines, but it cost them 13,000 feet of altitude to do so.

The pilots of CX780 didn’t have 13,000 feet to spare. They had already begun their descent.

The plane glided for a few minutes, dropping to 5,000 feet. They did everything they could to get the engines going.

Captain Malcolm Waters inched the thrust lever up slowly, trying to get some power into the engines. Nothing happened. Time was running out.

He moved it a little more… and slowly the engine throttled up. They managed to get enough thrust on one engine to maintain altitude. Relief. At that point, they knew they weren’t going to ditch into the South China Sea.

But there was a final sting in the tail. As they came in to land, Captain Waters pulled back the thrust to find that the right engine was stuck at 70% power.

Now the plane was going too fast. Cockpit warnings and alarms came hard and fast.

The plane touched down at a speed of 230 knots. The normal touchdown speed of an Airbus A330 is 135 knots.

They were way outside the envelope.

The plane bounced back into the air, banking hard left before Captain Waters regained control and brought it down a second time. He applied maximum brakes and managed to get reverse thrust out of engine 2.

The plane stopped just 300-metres short of the end of the runway.

But they still weren’t out of danger. Stopping at that speed pushed the brake temperature to over 1,000 degrees. Five tyres had deflated through thermal fuse plugs, as designed, but the remaining tyres could easily burst and rupture the fuel tanks.

They evacuated immediately. All 309 passengers and 13 crew got home safely.

Cathay Pacific Airways flight CX780 lost engine power mid-flight, but was piloted safely into Hong Kong Airport by Captain Malcolm Waters

I know most of you are familiar with the heroic Captain Chesley Sullenberger, who made an unpowered water landing on New York’s Hudson River after both engines failed. But I doubt you’ve heard of Cathay Pacific’s Captain Malcolm Waters and First Officer David Hayhoe.

I’ve read the report from the Chief Inspector of Accidents from Hong Kong’s Civil Aviation Department. Let me tell you, these guys are heroes of the same degree.

There’s no doubt flight CX780 could have ended in tragedy. Yet, the pilots received little recognition until 2014 when Waters and Hayhoe were awarded the Polaris Award, the highest hon-our in civil aviation.

This calibre of pilots is the reason I fly Cathay (I’ve flown well over 2 million miles with them).

The culprit of this near-disaster? Aviation fuel contaminated with salt water loaded in Surabaya.

Last month I spent ten glorious days on the slopes of the French Alps. The vast majority of friends and acquaintances on this trip were airline pilots with decades of experience flying for major commercial airlines.

Most had become senior training pilots or check captains, and a great number had begun their aviation careers in the military.

Over long lunches on the slopes and longer dinners back at the chalet, they traded stories. Tales of early flying days in Africa were particularly memorable.

Civil wars, coups and international conflicts, sketchy landings on remote jungle airstrips, ferrying dubious politicians, mysterious cargoes for cross-border deliveries to unknown recipients, medical relief flights, clandestine flights, setting up underground airlines to ferry supplies to sanction-ravaged countries… these guys have seen it all.

But it was one casual comment that really caught my attention. My good friend, a hugely experienced training and check captain, remarked how he found it a genuine pleasure to be in the cockpit with a top pilot. A “joy to watch” is how he described it.

How so?

The joy is found in that rare pilot who has a real vision of what lies ahead, beyond the scope of the radar.

It’s the knack of being able to know the unknown, and put the aircraft in a position to cope with what “might” be coming… a slight change of course, a shift in altitude, a command to the cockpit team to stand by.

This kind of pilot rarely gets caught out by events, which then require hurried decisions. Even for unanticipated events, he’s ready with a calm, rational response.

When Ian explained this to me, I thought of Captain Malcolm Waters and First Officer David Hayhoe.

These guys couldn’t possibly have anticipated what was to happen on that flight. It was only after years of investigation that the real cause was determined.

As Chris Kempis, chief Airbus pilot with Cathay Pacific, says:

“The most important thing to bear in mind is this is not a scripted or pre-trained event. We train for the events we consider the most likely and this was far from it. Most of us who are professional pilots hope we would behave in the same way. We don’t know for sure, but we hope we would meet the same standards. These guys have certainly proved there is a benchmark out there that is outstanding.”

Incidentally, we’re proud to have Captain Malcolm Waters as a subscriber to The Churchouse Letter.

He was kind enough to read through our account of flight CX 780 above for accuracy.

We asked him about the importance of his training on that fateful day…

“Absolutely, my previous training came to my aid... Also my experience flying before CX. I implemented a solution that had roots in flying light aircraft in Australia to make the approach, as well as applying Cathay Training in problem solving to aid decision making.”

The Pilot-Investor Analogy

How does all this apply to investing and the current market uncertainty? It’s an obvious analogy.

Most flights are uneventful. You take off as scheduled. Maybe you get a little turbulence here and there. You watch a movie. The food is average. You land.

The same is true with investing.

Despite what the 24-hour news channels would have you think, most of the time the markets that directly affect your portfolio are unexceptional. Up a little here, down a little there, but nothing to set the pulse racing.

What separates good investors from mediocre ones is anticipation and preparation. Hope for the best but be ready for the worst.

Because pilots and investors alike will be put to the test sooner or later.

Captain Malcolm Waters’ challenge was a genuine “black swan” style failure.

At the time, neither he nor the engineers knew what the hell was causing the problem. But he used ALL his training AND he kept a cool head. In doing so, he avoided catastrophe.

As investors, we cannot predict black swans.

But we can be prepared, keep a close eye on the radar, and not panic.

Right now, in global markets we’re experiencing heavy turbulence.

Equity markets across the world have taken a hammering this year. We’ve lost over US$6 trillion in market cap globally.

U.S. 10-year treasury yields are down 50 basis points (0.50%). Crude oil remains below US$30 a barrel.

We’re looking at a challenging “flight” in 2016. It’s bumpy right now, and from where I’m sitting, there’s a good chance that things will get worse before they get better.

And I’m not even talking about “black swans” here, I’m talking about what I see on my radar.

And what do I see? I see El Nino, OPEC, Syria, negative interest rates, commodity prices, debt, slow growth, deflation… let’s just say the radar screen is lit up right now.

Is China In Crisis?

What’s the biggest incoming risk on everyone’s radar?

Donald Trump?

Good guess, but for now lets look at China.

Or rather, the feared impending collapse of China that will bring down the rest of the world with it, if the majority of pundits and media outlets are to be believed.

There is no doubt that China’s economy is slowing. It is also clear that there are excess capacity problems, a worrying rise in debt levels, and other imbalances in the economy that need to be addressed.

But to conclude that China’s economy and its financial system are about to collapse is wrong.


. . .

In this edition of The Churchouse Letter Peter adds two more defensive investment recommendations for his readers. His existing defensive trades are outperforming by double digits.

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