The airlines are a hard sell right now, and I don't mean that they are difficult to part with. I mean that they are, right now, in free fall and this market abhors bottom fishing.
Think about it. Can you recall a group that was able to recover from a sustained free fall in ages? Can you think of any sector that's been able to bounce from a real hammering and come out on the other side?
Sure, one could say the biotechs have. Yet most are still well below their highs of earlier in the year. Some of the cloud stocks have come back but they, too, haven't gotten anywhere near where they were 15 months ago.
Now, those comebacks were injured by supply of the stock, as many initial public offerings of inferior merchandise blotted out any hope for a sustained rally.
This potential airline comeback is harder to imagine because this one's related to earnings, price to earnings multiples, and amazing outperformance for far longer than anyone thought possible.
Let's take the case of Southwest (LUV), which is the best and most profitable operator there is. When I spoke to CEO Gary Kelly last night, it was very clear to me that he's being far more disciplined than some pundits think. But it takes many to tango, and it doesn't matter if Gary's being disciplined if others aren't.
Gary said that May was coming in softer than he would like. That immediately says to me that the $3.46 consensus number for the year, the one that makes the stock seem like a bargain, is way too high. I hate buying stocks with number cuts just ahead, which his clearly the case.
Well, you might say, Southwest's stock is too expensive, how about buying American Airlines (AAL), which has a price-to-earnings ratio of 4?
Let me tell you something. That's a total red flag. Every time I have seen that low a price-to-earnings ratio, it is a sign that the future earnings are about to be slashed, maybe slashed drastically.
Now, I do not think this is the case of Bethlehem Steel, which sold at 2x forward earnings a few short years ahead of when it filed for bankruptcy. One of the best bets I ever made was to short Bessie, as we called it, betting that the reason why it sold at such a low price-to-earnings multiple is that the estimates had to be totally wrong. They were. Bethlehem ended up drenched in red ink the next year because of foreign steel dumping, and it never came back.
The airlines are in much better shape than Bessie when it comes to their balance sheets and there isn't anywhere near the capacity coming on as there was from China and Korea in the early '90s in the steel industry.
Still, the fact is that the estimates are too high and stocks do not bottom ahead of earnings estimate cuts. They bottom after the cuts. So here is what I wanted to do if I wanted to own LUV or any of the stocks in the group. I would wait for the cuts to occur. I would wait for the downgrades to happen. I would wait for the chartists to pronounce these as the biggest head and shoulders patterns known to man.
And only then would I do some buying -- no matter where the stocks are. But if history is any guide, and it usually is, I bet those buys occur lower, not higher, than where the stocks are now.
