A Rise in Oil Prices Sends Airline Stocks Tumbling Into a Bear Market

Anticipated as a promising year for airlines, marked by the resurgence of travel demand and the gradual fading of the Covid pandemic, an unexpected resurgence of the industry's long-standing adversary has taken center stage.

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Over the past three months, the price of oil has surged, particularly following the extension of supply cuts by Saudi Arabia and Russia earlier this month. This surge in oil prices has delivered a significant blow to airline companies, causing the S&P Supercomposite Airlines Industry Index to enter a bear market earlier this month. This marked a continuing and rapid decline from its recent highs in mid-July.

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This week, several major U.S. carriers revised down their profit projections for the third quarter, attributing the sudden spike in oil prices, along with escalating labor costs and reduced demand for domestic travel. In tandem with this, the average 2023 profit estimate for U.S. airlines has plummeted by 8% since the beginning of July, according to Trade Algo. Expectations for 2024 earnings have also dipped by 10% in the same period.

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George Ferguson, an analyst at Bloomberg Intelligence, highlighted, "Fuel is the biggest risk to airline profits right now. Airlines had lower fuel prices factored into ticket prices for the third quarter, and then oil moved dramatically. I don't think airlines saw it coming." Jet fuel, constituting approximately 25% of major U.S. airlines' annual operating expenses, had surged to nearly 30% in the first quarter of 2023 before retreating to around 20% in the second quarter. Ferguson anticipates that this percentage will climb once again in the final two quarters of the year.

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As of Thursday's close, the airline index has fallen by 24% from its peak on July 11, while the broader S&P 500 Index has gained 1.5% over the same period. This marks the airline index's second-worst performance over a similar span since the Covid-related shock, with the previous occurrence in the nine weeks leading up to June 2022, as per Bespoke Investment Group.

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On Friday, the group experienced a slight rebound, partially recovering from the decline, driven by major carriers such as United Airlines Holdings Inc., Southwest Airlines Co., and Delta Air Lines Inc.

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The recent oil price increase coincides with airlines grappling with high labor costs and declining demand for domestic travel as consumers face the impact of high inflation. Inflation data this week revealed an uptick in airfares in August, sparking concerns about passengers' ability to afford air tickets, thereby limiting airlines' capacity to pass on rising costs to travelers.

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George Ferguson noted, "If the consumer has some strength, you would look for fares to be increased to cover fuel. But my guess is that the consumer isn't strong enough to bear a large increase."

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Nevertheless, some believe that the wave of third-quarter warnings and the recent sell-off have removed uncertainties and positioned airline stocks for potential gains. The airline index has now entered an "oversold zone," a technical indicator suggesting that it may have fallen too rapidly and is due for a reversal. Despite this, market strategists suggest that any sustained recovery in airline stocks may take time, especially with oil prices remaining unpredictable, the outlook for air travel remaining uncertain, and investors seeking sectors with fewer uncertainties and stronger cash flows.

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Furthermore, the rally in oil prices, which is eroding airline companies' profits, has attracted investors to energy stocks, diverting capital away from airline stocks. The U.S. Global Jets ETF (JETS), comprising airline stocks, has experienced outflows for 16 consecutive months, while both the Vanguard Energy ETF (VDE) and the iShares Global Energy ETF (IXC) have seen inflows in July and August.

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Todd Sohn, ETF strategist at Strategas, noted, "They are losing out in pure competition for capital," highlighting that investors are increasingly turning to energy stocks. "Energy's gain is airlines' pain."

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