• • Bearish price action in airlines and energy

  • The pandemic hit both sectors hard

  • XOM and CVX have been falling steadily since 2018

• LUV and DAL have been under siege in 2020

• The end of the pandemic in 2021 could lift both sectors- Call options are the safest approach

In late 2018, the E-Mini S&P 500 futures contract traded to a low of 2316.75. Even though the risk-off period caused by the coronavirus pushed the futures to a lower low of 2174 in March 2020, the futures came storming back and were trading at the 3278.25 level at the end of last week. Compared to the 2018 low, the E-Mini was over 41.5% higher over the past two years.

The magnetic force of the stock market was not strong enough to carry two sectors higher. Energy-related shares and airline stocks have underperformed the stock market. Crude oil and natural gas are fossil fuels. When it comes to the environment, as investments, they joined the ranks of coal over the past years. Airlines have always been a troubled business. In the past, low oil prices had been a supportive factor for airlines. However, the global pandemic caused travel to grind to a halt.

Both sectors accumulated substantial debt levels with interest rates at historically low levels over the past twelve years. Airline and energy companies face a business environment where servicing those loans has become more than a challenge.

Warren Buffett is a value investor. During past financial crises, he burst on the scene to purchase beleaguered companies. Earlier this year, as risk-off conditions created bargains, the Oracle of Omaha uncharacteristically sheds his position in airline stocks.

The stock market made an impressive comeback in a V-shaped recovery since the March 2020 low. However, energy and airline stocks continue to be the redheaded stepchildren that have underperformed almost all other sectors. The ugliest performance during one period can often lead to the best opportunities. The prolonged crash course for airlines and energy companies could give way to a substantial recovery over the coming years. A reward is always a function of the risk of an investment. Airline and energy-related companies are risky as we move towards the end of 2020, but that could change in 2021 if the threat of the virus recedes and economic conditions improve.

Bearish price action in airlines and energy

The US Global Jets ETF product (JETS) holds shares of the leading airlines, including:

Source: Yahoo Finance

The JETS product holds an almost 21.5% exposure to Southwest Airlines (LUV) and Delta Airlines (DAL) with total net assets of $1.55 billion. An average of over 4.9 million JETS shares change hands each day, and the ETF charges a 0.60% expense ratio.

Source: Barchart

As the chart shows, JETS dropped from a high of $34.75 in early 2018 to a low of $11.25 in March. The ETF was trading below the $17 per share level at the end of last week.

The top holdings of the Energy Select Sector SPDR Fund (XLE) include:

Source: Yahoo Finance

The XLE holds an over 45% exposure to Exxon Mobile (XOM) and Chevron (CVX), with total net assets of $8.39 billion. An average of over 25 million XLE shares trade each day, and the ETF charges a 0.13% expense ratio.

Source: Barchart

As the chart illustrates, XLE fell from a high of $79.42 in May 2018 to a low of $22.88 in March. The ETF was trading below the $29 per share level at the end of last week.

The pandemic hit both sectors hard

Lower oil prices typically are bullish for airline stocks as they reduce operating costs. Meanwhile, the reason for the decline in the price of oil sent airline shares lower. The spread of coronavirus that caused lockdowns caused the demand for crude oil to evaporate earlier this year. The price of the energy commodity on the CME’s NYMEX division fell below zero for the first time since trading began in the 1980s. Business and pleasure travel ground to a halt as many areas banned all visitors. Coronavirus took a heavy toll on the energy and airline sectors. As the second wave of the virus is now spreading across Europe and with rising cases in the US, the pressure on energy stocks and airlines continues as we head towards the end of a very usual year.

While the stock market experienced an almost V-shaped recovery since March, the energy and airline sectors did not participate. High-flying technology stocks rose to incredible levels over the past months, leaving the debt-laden energy and airline sector in the dust. The stocks of many of the leading companies in these two sectors are trading at bargain-basement prices. The second wave that is now bearing down on Europe and the US is likely to push share prices even lower, which could create an opportunity for the coming year.

XOM and CVX have been falling steadily since 2018

The leading oil producers face a substantial challenge as they struggle through the pandemic. In August, the DJIA kicked Exxon Mobile (XOM) out of the index, replacing it with Salesforce (CRM), a technology company. Last week, XOM reported a quarterly loss and ended a four-decade streak of increasing its annual dividend, as the company expects more pandemic-related losses.

Source: Barchart

As the chart highlights, XOM fell from a lower high of $87.36 in September 2018 to a low of $30.11 per share in March. At below $33 as of October 30, the stock remains near the lowest level in almost two decades. The bad news keeps on coming for the once-mighty Exxon Mobile. While the company did not increase its divides, it continues to pay shareholders an over 10% yield.

Meanwhile, CVX remained a component of the DJIA. However, its performance has reflected the carnage in the energy sector.

Source: Barchart

CVX shares reached a lower high of $133.88 in early 2018 and fell to a low of $51.60 this March, the lowest price in a decade and a half. At $69.50 per share at the end of last week, Chevron was a lot closer to the lows than the highs at the end of October. XOM and CVX did not appreciate the leading stock market indices. The path of least resistance was pointing lower as we head into November, and the second wave of coronavirus could send the shares below the March bottoms in both stocks over the coming weeks.

LUV and DAL have been under siege since 2018

The demand for air travel disappeared earlier this year, and it has remained at a very low level. Until a vaccine can provide immunity, many people will opt to stay at home and not venture into a tube that transports them to destinations. For many, the fear of travel in a contained environment is likely to remain after the pandemic ends.

LUV traded to a high of $66.98 in late 2017; in May 2020, the share fell to a low of $22.46. While the stock recovered, it was below the $40 level at the end of last week.

Source: Barchart

DAL reached its peak at $63.44 in mid-2019 before the stock dropped to a low of $17.51 in May 2020. DAL was at the $30.64 level on October 30.

The end of the pandemic in 2021 could lift both sectors- Call options are the safest approach

Locating value in the stock market is no easy task these days. The most popular companies in the technology sector are trading at levels where the air is thin, and the potential for significant corrections has increased with the share prices. Meanwhile, the US and European governments are looking to reign in the power of the leading technology companies, which could impact earnings and share prices in 2021.

Oil companies and airlines are trading at bargain levels. COVID-19 has decimated their earnings, and it will take a long time for the leading companies to recover and return to profitability. A second wave of the virus that has already started is likely to take the sectors lower before the end of 2020.

Companies like XOM, CVX, LUV, and DAL are likely to survive the pandemic. While they continue to cut expenses and shrink their workforces, the end of the coronavirus in 2021 would allow them to return to a more normal environment for energy and travel demand. I do not favor an aggressive approach to buying shares of these companies at their current prices. I would be a scaled-down buyer, leaving plenty of room to add on the downside when it comes to the four companies and the XLE and JETS ETF products, which diversify risk. The two ETFs have substantial exposure to the four companies.

I would look to purchase long-term call options for expiration in 2022 to protect capital and limit risk. Buying a call option limits the risk to the premium, while call option owners benefit from 100% of the price appreciation above the option’s strike price plus the premium.

Airline and energy companies have been on the same crash course in 2020. The end of the pandemic could allow for a smooth landing and a period where they catch up with the rest of the market that has left them in the dust.

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DAL shares were trading at $29.88 per share on Monday morning, down $0.76 (-2.48%). Year-to-date, DAL has declined -48.55%, versus a 4.36% rise in the benchmark S&P 500 index during the same period.

About the Author: Andrew Hecht

Andy spent nearly 35 years on Wall Street and is a sought-after commodity and futures trader, an options expert and analyst. In addition to working with StockNews, he is a top ranked author on Seeking Alpha. Learn more about Andy’s background, along with links to his most recent articles. More...

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