The airline stocks that were hot and soaring over the past few years suddenly lost their altitude in Wednesday trading session as the shares of major carriers nosedived as much as 10% on concerns that growth might outpace travel demand. This could result in lower fares and thinner profit margins.

This is because cheap fuel is encouraging carriers to increase the number of seats at the current fares, breaking the competitive discipline that helped the industry to earn record profits in the past (read:Transport Leading Q1 Earnings Growth: Are ETFs Too?)).

U.S. Carriers Growing Capacity

Most of the airlines are expanding rapidly with Southwest Airlines (LUV- Analyst Report) expected to increase capacity by as much as 8% this year and JetBlue (JBLU - Analyst Report) likely to add 7–9%. The capacity growth plan is at a whopping rate of 31% for Spirit Airlines (SAVE - Snapshot Report). On the other hand, Delta Air Lines (DAL - Analyst Report) and American Airlines (AAL - Analyst Report) would add 2% seats each this year, much lower than the low-cost carrier expectations. Further, United Continental (UAL - Analyst Report) projects 1–2% addition of capacity.

The capacity additions could result in a possible price war between legacy and low-cost airlines.

Market Impact

Given this, United Continental and American Airlines were the hardest hit, losing more than 10% at the close. This was followed by declines of 9.1% for Southwest, 6.9% for JetBlue, 6.7% for Spirit and 5.6% for Delta Air Lines. Other carriers including SkyWest (SKYW - Snapshot Report), Republic Airways Holdings (RJET - Snapshot Report), Alaska Air Group (ALK - Snapshot Report) and Allegiant Travel (ALGT - Snapshot Report) were down nearly 4.6% each.

The awful trading in these stocks sent the airline ETF – U.S. Global Jets ETF ((JETS - ETF report)) – in deep red on the day. The fund – debuted in late April – plunged over 5%. The product tracks the U.S. global Jets Index that looks to offer global exposure to commercial airlines, aircraft manufacturing, and airport industries (read: Inside the Flight of a New Airline ETF (JETS - ETF report)).

In total, the fund holds 31 stocks in its basket with the largest double-digit allocation going to DAL, LUV, AAL and UAL. These four firms combined to make up for 44% of total assets while other company holds no more than 4.5% share. The product has attracted $17.2 million in its assets base in less than a month and charges 60 bps in annual fees.  

Bright Summer Outlook

Despite the brutal plunge, airline stocks and the ETF are anticipating sunnier days in summer. This is especially true given the optimistic view from the Washington-based trade group Airlines for America.

The group expects airlines to see the busiest summer ever this year buoyed by an improving economy, accelerating job market and rising consumer confidence. The demand for U.S. air travel would hit a fresh high as 222 million travelers (or 2.4 million a day) are expected to fly from June 1 through August 31, up 4.5% year over year and much higher than a record of 217.6 million travelers seen in 2007 (see: all the Industrial ETFs here).

Further, international travel is also expected to increase with 31 million travelers or 332,000 per day boarding flight. According to the U.S. largest airline trade association, Canada, Mexico, the United Kingdom, Germany, and Japan are the top five hot destinations this summer.

In order to accommodate higher travel demand, the U.S. airlines will add flights, boost the number of seats, and deploy new and larger aircraft. Notably, the carriers would increase the number of available seats by 4.6%, or 126,000 per day, during this period with most seats on flights between the U.S. and Mexico, the United Kingdom, and China.

Moreover, the airline industry has a solid Zacks Rank in the top 40% at the time of writing, suggesting outperformance in the months to come.