What happened
On Friday, investors were digesting fresh data that suggested a "Goldilocks" economy -- not too hot, but not too cold -- is still a reasonable forecast for the quarters ahead. That would be good news for a whole range of industries including airlines, a sector that could be at risk of seeing demand dry up if consumers are feeling stressed.
Airline investors reacted to the latest data with a cheer, sending shares of United Airlines Holdings (UAL -2.52%), American Airlines Group (AAL -2.18%), and Spirit Airlines (SAVE -2.90%) up 5% apiece on Friday.
So what
Airline investors are doing their best to be economic forecasters right now. The airlines came into 2022 hoping for a year of recovery, with strong pent-up demand giving revenues a boost and helping carriers rejuvenate balance sheets that were bruised during the pandemic. The summer demand has developed as expected, but airlines have been forced to deal with unexpected headwinds including higher labor and fuel costs.
Image source: Getty Images.
On Thursday, several airlines provided updated guidance suggesting that although costs are higher, strong pricing power is helping them to offset those elevated costs. That's good news for the time being, but it could change on a dime if rising inflation diminishes consumer confidence and spending and causes that strong pricing power to evaporate overnight.
That's why the sector reacted so favorably to Friday's macroeconomic data. The closely watched core personal consumption expenditures (PCE) provided a hint that inflationary pressures might be easing. Headline PCE increased by 6.3% in April over a year ago, down from 6.6% in March. And separate data showed that personal spending, adjusted for inflation, accelerated in April.
It's certainly not data that suggests the battle against inflation is over, but it does at least provide a glimmer of hope that the rate of increase is slowing. And the personal spending data indicates that Americans are not yet changing their habits due to inflation -- good news for big-ticket, nonessential items like airplane tickets.
For the airlines, such an outcome would likely be viewed as good enough. The hoped-for 2022 recovery is now unlikely since so much of the added revenue is going to offset costs instead of to pay down debt. But the airlines can survive the status quo, and investors are reacting positively to the data suggesting that conditions are not deteriorating.
Now what
Of course, there are limits to the good news. The airlines will continue to face cost pressures for the foreseeable future. Even if fuel costs fall back to 2021 levels, the airlines are struggling to find enough flight crews to complete their schedules, let alone think of expansion, so labor costs are likely to be on the rise for some time to come.
The risk in investing in airlines has come down substantially, but the upside still remains a long way off. Investors buying in today should be warned that a full recovery, including a return of international and business travel, could take until the second half of the decade. And there are still potential downside risks that have to be considered, including the threat of a new pandemic wave that could at least temporarily tamper travel demand.
Investors should resist the temptation of buying into the rally. If recent history is a guide, these airline stocks will continue to trade based on overall market sentiment and the latest reads on the economy. There is likely limited downside to waiting to see what bookings look like past Labor Day before climbing on board.
