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Airline Stocks are for Trading not Holding

Written By Briton Ryle

Posted October 23, 2014

Airline stocks should come with those little paper bags you get aboard their planes, perhaps even those oxygen masks that drop from the ceiling. Over the recent stock market correction, airline stock holders needed all the oxygen they could get to save them from passing out.

As if the normal market volatility wasn’t enough, the Ebola scare stemming from the first related death on America’s shores gave rise to speculation that travel to certain regions of the world would be restricted, and that added passenger screening procedures would increase airline operating costs.

After soaring higher and higher since the previous correction of 2011, airline stocks fell from the sky during this current correction from September 19th to October 13th as graphed below — with United Continental Holdings, Inc. (NYSE: UAL) [blue] falling 18%, Delta Air Lines, Inc. (NYSE: DAL) [orange] dropping 20%, American Airlines Group Inc. (NASDAQ: AAL) [beige] plunging 22%, and Spirit Airlines, Inc. (NASDAQ: SAVE) [purple] crashing 26%.



Yet since then, with the Ebola threat diminished and broader market sentiment improving, the four largest U.S. airline companies have rebounded significantly as noted below — with Spirit climbing 17%, Delta and United rising 21%, and American soaring 30% higher.



But are the airlines going to relapse once again, especially if oil prices rise back up to their previous $100 per barrel mark over the next few months as many expect? You will likely be pleasantly lifted by analyst estimates for U.S. airline stocks over the remainder of this year, 2015, and beyond. If the trend continues, it will be up, up, and away with them all.

Until the next crash, of course, at which time it’s “Look out below!” Investors can still benefit from airline stocks, however, if they approach them the right way. Airlines are not meant to be held, they are meant to be traded.

Airlines Are Best Traded, Not Held

The problem with airlines, of course, is that they are economic amplifiers. That is, when the economy falters, airlines falter more; when the economy improves, airlines improve more. And it all centers on expenses.

Airlines have the nasty habit — forced into it, really — of repeatedly writing off massive amounts of losses during or shortly after a major economic downturn. In just the first 14 years of this millennium there have been at least two such major write-down events in the airline industry: following the 9-11 attacks of 2001, and following the economic crisis of 2008-09.

In both periods, the airline industry underwent major restructuring, with airlines consolidating and/or entering bankruptcy protection while they restructured. In such “book-cleaning” events, shareholder equity is used to cover debts, causing stocks to plunge. During the restructuring, pensions are terminated and seniority is lost, reducing labor costs significantly. What emerges out the other side is a new, refreshed, revitalized airline company with low labor costs, low debt, and high expectations.

This is the real reason why airline stocks are so volatile. It’s not just because of changes in the economy, but because of how the airlines react to those changes. They simply collapse themselves down to the ground and dump all their liabilities.

For this reason, then, investors would be wasting their time holding airline stocks for longer than a few years, since these major restructuring events befall the industry frequently, every 5 to 10 years or so. (In the last 14 years there have been two.)

Instead of holding long term, investors should trade the airlines, picking them up after they have collapsed and holding them for just a handful of years. If you had done this the last few times the airline industry went through this “soar-crash-burn-soar-again” cycle, you would have done quite well for yourself, as the following graphs show.

Buy the Crash, Sell the Climb

The last great book-cleaning cycle in the airline industry that we have charts for is from the 2008-09 financial crisis, although the airlines began hurting as early as late 2007.

As noted below, from late October of 2007 until the depth of the crisis on March 9th, 2009, where the S&P 500 index fell some 55%, Delta [blue] fell a whopping 80%, American Airlines (AMR) [purple] fell 83%, while United [blue] crashed some 93% — all within a year and a half.



But with a few strokes of the magic pencil (and eraser) — presto! The airlines are set to soar again — consolidated, restructured, and revitalized. And soar they did, as noted below, with Delta ascending 250% and United climbing more than 650% within just 1.5 years by November of 2010. During this time, however, American Airlines [purple] was undergoing major restructuring, with the magic pencils still hard at work writing off debts, terminating pensions, and using shareholder equity to pay for it all.



At this point, the market was about to enter another correction, which took place at the end of the chart on July 21st, 2011. But notice that the airlines reached their peak in November of 2010, a full eight months before the market fell from the sky. Selling into strength is a must for airline stocks, as you just can’t tell when they are going to peak.

When the markets crashed again, of course, the airlines fell harder as they always do, as plotted below. During this correction from July 21, 2011 to August 8, 2011, where the S&P 500 fell 16.5%, the newcomer Spirit fell 18%, United fell 18.3%, while Delta dropped 19%.



Was that a good time to pick up airline pieces off the ground? Absolutely. Had you done so, you would have enjoyed stellar gains until the next correction — the one we just had. From August 8, 2011 until September 19, 2014 (just four weeks ago), where the S&P gained just over 75%, United has ascended 200%, Delta has soared 480%, and Spirit has skyrocketed 535%.



From there — the start of the recent correction on September 19th — we go back to the first two graphs at the top of the page, showing the airlines’ deeper declines and steeper ascents than the S&P 500.

Traders’ Advantage

In airline stocks, therefore, it’s the short-term traders who have the advantage, not the long-term holders. Just as a point of interest, if you were able to time the past few peaks and valleys in the airline stocks as noted in the graphs above (naturally no one can do that, but just to illustrate the advantage) these would have been your results…

Buy March 9, 2009 / sell November 25, 2010 / buy August 8, 2011 / sell September 19, 2014 / buy October 13, 2014. By October 22nd (yesterday) you would have:

  • SPY ETF total cumulated long and short gains = $145.25 per share / $68 first price = +213.60%
  • Delta total cumulated long and short gains = $48.40 per share / $4.25 first price = +1,138.82%
  • United total cumulated long and short gains = $66.50 per share / $4 first price = +1,662.50%

Of course, no one can time these market turning points as well as that. But employing a scaled buy-down / sell-up method where a certain amount of shares are purchases every $5 down and sold every $5 up, for example, would certainly allow you to trade the airline stocks rather nicely, buying into the dips and selling into strength.

Might now be one such entry point? Starting a trading strategy like this is nothing to fret over, since no one knows if prices will be better or worse tomorrow. But the great thing about such a scaled trading method is that even if you don’t enter at the perfect point, the systematic buying-down and selling-up procedure will lock-in profit as you go regardless of your entry point.

In this way, traders can embrace volatility — which there will be much more of over the years as monetary policy slowly tightens and interest rates return to normal — instead of fearing volatility. If they are traded instead of held, airline stocks can be great vehicles for capturing their notorious volatility and converting it into profit as they soar, crash, and soar again.

What of those future estimates? Where the S&P 500 is expected to grow its earnings by a 10.02% annual average over the next five years, Delta is expected to grow its earnings by 13.00% annually, Spirit by 29.95% annually, United by 36.45% annually, and American by 48.75% annually.

These aren’t stock price projections, though, but earnings growth. Yet as they are expected to beat the S&P’s average earnings growth, now looks like a good time to climb aboard the airlines. Just don’t forget to trade them instead of holding them.

Joseph Cafariello