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Chart Advisor | Focus on the Price

By Gordon Scott, CMT

Monday, June 01, 2020

1. Nasdaq moves on to new highs

2. Staying above the fray

3. Uncertain future includes unlikely bankruptcy

Market Moves

The S&P 500 (SPX) and the Nasdaq 100 index (NDX) both closed roughly one-third of a percent higher while making new highs. The market seemed to shrug off the news of the protests throughout the U.S. over the weekend, suggesting that this poignant moment, like so many others, will likely pass with no serious repercussion on the financial markets.

The chart below looks at how the Invesco's Nasdaq 100 ETF (QQQ) has fared since the lows in March, and how the three most influential components of that index, Apple (AAPL), Microsoft (MSFT), and Amazon (AMZN), have performed. All are similarly impressive, but the fact that the current moves occurred after events strong enough to brush aside headlines of all kinds — Coronavirus updates, U.S. and China tensions, stimulus programs, government investigations, OPEC efforts or even the reopening of economies around the world — is actually fairly significant.

It isn't commonly considered, but political and social problems historically have very little impact on the movement of the markets, unless such events actually disrupt the flow of investors' money. For example, it is a little known fact that during the Great Depression, crop-crushing weather actually had more negative impact on stock prices than all the battles of World War II.

So if investors aren't fazed by the protests, it is quite possible that real opportunities still abound in the market among oversold sectors. They aren't hard to find. The obvious candidates include cruise companies and airlines. Last week we looked closely at cruise companies, perhaps airlines are worth a look today.

Staying Above the Fray
Active investors know that when investors send stocks to new highs, that means a continuation of the bullish trend. During such times stocks that have been sold off heavily because of special circumstances can sometimes provide the fastest gains as conditions normalize. Airlines seem to be a clear candidate for considering the possibility of a strong rebound in the months ahead.

The chart below compares US Global Investors' airline industry index ETF (JETS) with six of the most heavily capitalized airline companies including Ryannair (RYA), Chinese Eastern Airlines (CEA), Southwest Airlines (LUV), Delta Airlines (DAL), American Airlines Group (AAL), and United Airlines Holdings (UAL). The earliest signs of an uptrend appear to be emerging, but most of these stocks show only a sideways trend.

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Uncertain Future Includes Unlikely Bankruptcy

The worst faring stock among major airline companies is UAL. Shares have fallen as much as 80% since the beginning of the pandemic. It seems likely that if any company is in danger of failing (going bankrupt), it would be United Airlines Holdings. However, option market makers do not appear to think that will happen.

The chart below shows the option chain and implied volatility scores for UAL options that expire over the next 18 months. None of these options are priced with a probability of the company going to zero before expiration except the last two, which expire in January 2021 and January 2022 respectively. Even these are priced with less than a 1% chance of that happening.

In fact, a deeper analysis shows that there is a nearly 80% chance shares of UAL will not fall lower than $8 per share between now and the end of the year. This provides a line in the sand for speculators to work with, because either this airline goes broke, or it finds a way back to profitability, in which case the stock price could be worth double or more what it is now. This makes for an attractive risk-reward thesis.

The Bottom Line

Stock market indexes continued higher despite unprecedented civil unrest. The surprising confidence of investors implies that market opportunities still exist. One oversold sector, airlines, offers an attractive risk-reward profile right now.