Why Airlines Are Ready For Another Leg Lower

The Transportation stocks are the big losers this year. With most of the major U.S. Averages flat for 2015 (except the Nasdaq100 up 10%) the Dow Jones Transportation Average is down over 10% year-to-date. The underperformance out of the space is telling and I believe there is more to come. Today we are focusing specifically on the Airline stocks, which I think are about to see another leg lower, likely over 20%. The risk here is also very well-defined, which for those of us who are here to make money (not noise), is all that actually matters.

Here is a longer-term chart of the Amex Airlines Index. The first thing that stands out is the uptrend from the March 2009 lows. This level marked an important bottom, not just in Airlines, but for the U.S. stock market as a whole. Notice how in the first quarter of 2009, the Airline Index did NOT make new lows below it's Q4 2008 trough. This relative strength was the tell before such tremendous outperformance ever since. The Dow Transports rallied over 330% from those lows, crushing the returns of the other indexes. Today we are seeing the opposite as it breaks the uptrend line from those 2009 lows and struggling vs the other averages all year:

Also notice how prices reached the 161.8% extension of the 2007-2009 decline, hovered around that area, and then rolled over hard. This exhaustion is further evidence that more selling is likely coming soon.

Short-term, we can see prices below a downward sloping 200 day moving average. Bad things tend to happen when prices are trading below this downward sloping smoothing mechanism. Another issue is the overhead supply. Prices are holding below all of that former support near 98 from the first half of the year. All of that overhead supply is an issue, not to mention the downtrend line from the January highs. That is way too much trouble to get me long Airlines:

Now look at the uptrend line from the August lows. That's now broken as well. When what is typically a continuation pattern instead resolves itself to the downside, the market is speaking. It's up to us to listen. This is the case with that "bull flag" throughout the second half of October, that resolved lower. We take this as further evidence of overhead supply.

What can change my mind? We always want to make the counter-argument because the one thing that we do know is that none of us know what will happen. If the circumstances change, then we change our tune, simple as that. First of all, we need to see prices climb back above the broken uptrend line from the August lows. Then we need to consolidate those gains, allow the declining 200 day moving average to flatten out and begin to slope higher. Then we need to take out that broken support from the first half of the year near 98. In order to accomplish this difficult feat, it will take time. It's not going to happen tomorrow and it will be a headache along the way. So to get long hoping for that outcome makes little sense to me. I would prefer to be wrong and let time ultimately get me long, if that eventually becomes the case.

On a more realistic note, we want to err on the short side of airlines. From an execution standpoint, we want to be short a basket of Airlines (also see: $JETS) if and only if prices of the Airline index are below the highs from the Summer of 2014. This is a big level for us which represents that former resistance, but also the broken uptrend line from the 2009 lows. A rollover below Monday's reversal should trigger a massive sell-off. That to me is the highest probability outcome from where we sit today.

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