I chose the U.S. Global Jets ETF (NYSEARCA:JETS) as my pick for our Best ETFs of 2020 contest. Quite obviously, that was the wrong choice.
As I’ve written before, it’s tempting to blame the 46% year-to-date plunge in the JETS ETF on the novel coronavirus pandemic. And, certainly, the billions of dollars of losses suffered by airlines this year played a significant role in that plunge.
But the fact is that the industry didn’t prepare for a calamity of any sort. That includes a pandemic of some kind, which was a known risk. Indeed, the major U.S. airlines listed such an event in the “Risk Factors” sections of their respective Form 10-K reports filed with the U.S. Securities and Exchange Commission.
That aside, this still is a cyclical industry that came into 2020 riding the longest macroeconomic expansion in U.S. history. Yet outside of Southwest Airlines (NYSE:LUV) — historically the exception to the airline rule — major U.S. airlines kept their heavily leveraged balance sheets. That left zero room for error when disaster struck.
All told, an industry that historically has disappointed investors did so once again. In the process, it shattered the trust that had been rebuilt following the financial crisis.
But, at this point, some investors see value in the JETS ETF. After all, about 40% of JETS’ assets are concentrated in the four major airlines. Those airlines have delivered some good news of late. Hopes for a vaccine are rising, and airlines seem as a good a “return to normalcy” trade as there is.
Yet there’s more going on here than just the short-term losses driven by the pandemic. The long-term effects on the industry will be severe as well. Considering those effects, I’m not close to ready to return to my errant bullishness toward JETS, or the sector more broadly.
Timing the Bottom
To be sure, we’re getting some good news from the sector of late. There might be enough to suggest that JETS could be one of the best ETFs of 2021 after being one of the worst of 2020.
Passenger demand is returning. Indeed, last week JetBlue (NASDAQ:JBLU) was the latest airline to cite improving trends. Capacity has been slashed, which should lower costs. Rock-bottom jet fuel costs help as well.
The federal government has stepped up with aid, mitigating near-term bankruptcy risk. And bond market investors are dipping in a toe. Delta Air Lines (NYSE:DAL) is raising $9 billion in a bond offering that was upsized from $6.5 billion. The bonds are backed by the company’s frequent flyer program, but still show that investors are at least willing to lend money to major airlines, if only on a secured basis.
And yet the JETS ETF hasn’t really budged. The fund has rallied 50% from March lows, but actually trades below the peak of the initial bounce that month.
Down by almost half, meanwhile, the math seems potentially favorable. All JETS has to do is return to past levels in several years to be one of the best ETFs out there. A five-year return to normalcy, for instance, would suggest annualized returns of about 14%. In a zero-interest rate environment, investors would be thrilled with that kind of performance.
Why JETS Isn’t One of the Best ETFs
The problem with that simple math, however, is that it’s based on a shaky assumption: that the sector can, or should, return to past levels. For multiple reasons, that’s unlikely to be the case.
The first is the cyclical nature of the industry. In theory, cyclical stocks like airlines should become cheaper relative to earnings toward the end of the cycle. Indeed, that’s what happened in 2018 and 2019, when major airlines often were trading at less than 10x earnings.
In practice, however, cyclical stocks usually aren’t cheap enough at the top. With economic damage from the pandemic likely to linger, it’s going to take years simply for investors to get comfortable with the macroeconomic risk in the sector.
It’s also going to take investors years to get comfortable with the industry itself again. The case for airlines and the JETS ETF, as I argued coming into this year, was that airlines had learned their lesson.
I wasn’t alone in thinking so. Warren Buffett reversed his well-known antipathy toward the industry, and his Berkshire Hathaway (NYSE:BRK.A, NYSE:BRK.B) became a shareholder of all four major airlines. Now, it seems like the “same old, same old” for the industry, and Berkshire is long gone.
Finally, the industry is facing significant pressure on two of its most profitable markets. The rise of Zoom Video Communications (NASDAQ:ZM) presages fewer in-person meetings, and reduced spending by less price-sensitive business travelers. International demand, too, will take a hit, particularly with foreign travelers likely to cast a wary eye toward the U.S. for some time to come.
This isn’t a case of just bouncing back. The effects of the pandemic will last long after normalcy returns.
On the Sidelines
On the whole, then, the decline in the JETS ETF seems logical. Short-term losses are material. Debt raised to fund those losses will require billions more in interest payments over time, and that leverage lowers equity values as well.
Meanwhile, this is an industry that simply will have to shrink. There literally isn’t enough storage for idled jets right now. Capacity has been slashed, and won’t come back for years, if it comes back at all.
Those problems don’t go away once a vaccine arrives. The news will get better, but I’m skeptical it will get good enough. I was wrong in calling JETS one of the best ETFs for 2020, and it’s possible I’m missing out on calling it one of the best ETFs for 2021. But the pre-pandemic bull case was shattered, and it’s still awfully hard to build a new one.
On the date of publication, Vince Martin did not have (either directly or indirectly) any positions in the securities mentioned in this article.
After spending time at a retail brokerage, Vince Martin has covered the financial industry for close to a decade for InvestorPlace.com and other outlets.