Two steps forward, one step back. The employment numbers for May were terrific, but the jobs report for June, which the Department of Labor released today ahead of the Fourth of July holiday weekend, was much less impressive. The economy added 223,000 jobs last month, below the 230,000 consensus estimate (the figure for May was revised downward by 26,000 to 254,000); although the unemployment rate fell from 5.5% to 5.3%, the decline was driven by workers dropping out of the labor force, as the participation rate fell to 62.6% from 62.9%. Finally, average hourly earnings were flat relative to May, and the 0.3% increase reported for May was revised lower to 0.2%.
All told, it's an underwhelming report; while it certainly doesn't scupper the "recovery" thesis, it doesn't do anything to burnish it, either. Perhaps that explains the lack of direction in the U.S. stock market on Thursday: the Dow Jones Industrial Average (DJINDICES: ^DJI) and the broader S&P 500 (SNPINDEX: ^GSPC) were down just 0.34% and 0.27%, respectively, at 1:30 p.m. EDT. The technology-heavy Nasdaq Composite was down 0.4%.
Will airline shares remain grounded?
Shares of American Airlines Group Inc. (NASDAQ: AAL), Delta Air Lines (NYSE: DAL), United Continental Holdings Inc. (NYSE: UAL), and Southwest Airlines Co. (NYSE: LUV) significantly underperformed the broad market Wednesday, falling between 1.4% and 2.8%, in the wake of reports the Justice Department is investigating possible collusion among airlines to limit seating in order to support prices. These four airlines represent approximately four-fifths of U.S. air traffic.
This is the sort of news that commands the interest of a contrarian, value-driven investor like me, and it's an opportunity to have a quick look at the sector.
The shares of this group have been volatile over the past year in a placid market:
After tumbling in the first part of October due to vastly exaggerated fears concerning Ebola, the shares have trended in opposition to the price of oil, which fell dramatically at the end of last year and into 2015, a decline that has since partially retraced (the bottom blue line in the above chart represents the price of West Texas Intermediate crude oil). Jet fuel is the largest single cost for airlines.
Starting from the bear market low of March 2009, however, airline shares' longer-term trend has been one of huge outperformance. That success reflects regulators' benign attitude toward a wave of consolidation that has enabled carriers to eliminate excess capacity and improve pricing power. Can that outperformance continue, reversing the most recent price action? What is certain in the medium term is that airline sector consolidation has run its course, while the price of oil is unlikely to provide any tailwind.
In his 2007 annual letter, Berkshire Hathaway CEO Warren Buffett warned:
The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers. ... The airline industry's demand for capital ever since that first flight has been insatiable. Investors have poured money into a bottomless pit, attracted by growth when they should have been repelled by it.
I don't think airlines are as problematic for investors now as they were when Buffett invested in USAir preferred stock in 1989. In fact, the airline industry now shares multiple characteristics with railroads (oligopoly structure, heavily regulated, sensitive to fuel costs, etc.), an industry to which Berkshire's CEO is now a convert. The real problem is that, at current valuations, airline shares don't offer a significant "margin of safety" -- value hounds will just have to wait for more headline risk to unfold, courtesy of the Justice Department.