The Economic World Is Upside-Down -- Here's How I'm Profiting

Amber Hestla's picture

Thursday, June 22, 2017 - 12:00am

by Amber Hestla

Compared to the past, there's something fundamentally different about the challenges central banks face today -- further proof that we're in uncharted economic waters.

Low interest rates, even negative rates in some countries, are a prime example. A couple of years ago, a chart of interest rates over the past 5,000 years began to circulate. One version of that chart, shown below, highlights that rates fell to a nearly 400-year low in the Great Recession.

One noted economic commentator, James Grant, asked, "If these are the first sub-zero interest rates in 5,000 years, is this not the worst economy since 3,000 BC?"

I don't believe this is the worst economy in history, but I am seeing more and more indicators that this is an unprecedented economy. Within the past few years, we have seen many longstanding economic relationships change. Among them is the number of unfilled jobs. Historically, we've come to expect that there will be more job seekers than jobs. That relationship changed in 2015.

Now, there are more job openings (the blue line in the chart above) than jobs (the red line). In theory, this should lead to higher wages and inflation, but that isn't happening right now. That poses a tough question for the Federal Reserve  when it comes to interest rates. Should they raise rates, an action that has usually been taken to keep inflation low, even when there is no sign of inflation? So far, that's been the case.

Even under the best circumstances, the Fed has a tough job. Right now, it's even tougher because so much is changing. Ten years ago, economists could have argued negative interest rates were impossible. Five years ago, economists would have argued there should always be more new hires than job openings because that's the way the jobs market works. Now, the charts show both of those arguments to be wrong.

I believe the Fed understands the economy is changing, and they're doing their best to understand what's different this time. Investors also need to understand markets change. In particular, the prospects of companies and even entire industries can change. We're seeing positive change in a number of industries right now, but one especially is standing out to me.


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All Of A Sudden, Airlines Are Great Stocks To Own
Airlines, as a group, are just now breaking above their 2000 highs. In the past, the industry has suffered for a number of reasons. The primary reason was that management would engage in destructive price wars and buy new aircraft whenever business happened to pick up. It seemed that the industry failed to follow any type of long-term plan. The chart below shows that the industry has turned substantially higher in the past few years. 

Airline stock prices now seem to be undervaluing the future. This makes sense -- investors tend to anchor their perceptions on what they saw in the past. Although airlines have done well in the past few years, investors have been waiting for proof that management really is focused on the long term. The chart above shows the industry is now reaching new highs, an indication that investors finally appear to be convinced.

Warren Buffett is among the investors who are bullish on airlines. In the past year, he has invested nearly $10 billion in the industry. This marked a significant turnaround in his thinking compared to 2002, when he said, "If a capitalist had been present at Kitty Hawk back in the early 1900s, he should have shot Orville Wright. He would have saved his progeny money." Now, he has invested billions in the largest airlines. 

Buffett purchased billions of dollars' worth of stock in four airlines, investing $2.1 billion in American, $2.2 billion in United, $2.4 billion in Southwest and $3 billion in Delta. He's betting on the industry rather than the individual management teams. This is a break from his usual process, which involves identifying a market leader and taking a big stake in that company. His decision to invest in all four major airlines indicates he didn't find much to differentiate the companies from each other. 

I agree with Buffett that all of the airlines offer value and all are worth considering as investments. This will be the case until investors re-anchor their positions on the industry. Eventually, investors will recognize that the companies are profitable and capable of delivering steady growth. When that happens, the price-to-earnings (P/E) ratios of the industry will rise. Until then, value investors should be accumulating positions.

Generate 4.3% And Get The Chance To Buy AAL At An 11.3% Discount
All of the major airlines are undervalued, including the stock I recently recommended to my premium Income Trader readers: American Airlines Group (NYSE: AAL).

AAL is currently trading with a P/E ratio of about 12 based on its earnings over the past 12 months. Looking ahead, analysts expect the company to report earnings per share (EPS) of $4.78 for this year and $5.39 next year. The stock is priced at just 10 times this year's estimated earnings. AAL offers deep value in a market that is largely overvalued. 

The same analysis can be done for any of the major airlines, as a variety of measurements all point to undervaluation. Because of that, when airlines are on my list of potential trades, I focus on the trade itself rather than the company. I search for the largest reward and least risk among the major airlines. I zeroed in on AAL because it is usually among the last companies in the industry to report earnings. 

For the purposes of my newsletter, that means July options should expire before the earnings are released, decreasing the risk on the trade. 

If our trade works as planned, we'll generate a quick 4.3% in income. And even if we're wrong, we'll get the chance to buy AAL at an 11.3% discount to recent prices.

Talk about a win-win.

That's the benefit to using my conservative options strategy in Income Trader. Rather than recognizing the value in AAL and simply buying shares, we hedge our risk even further by TELLING the market what we'd like to pay for the stock (less than recent prices). And for our trouble, we earn income in the process. 

If you want to know how to do this, I've got everything you need to get started. Simply follow this link to learn more.

Amber Hestla does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.