Airlines TakeFlight Friday May 2, 11:56 AM EDT Since the terrorist attacks of September 11, the words airline and leadership haven't been heard in the same sentence very often. That isn't the case today, however, as the airlines are leading the broader market. Credit Merrill Lynch for that development as the firm issued a research note this morning that has money flowing into the sector. From a trading perspective, the rotation is understandable, but from an investment perspective, it seems pretty silly. To that end, Merrill Lynch began its note with three telling acknowledgments. First, it provided its net loss forecast for the industry for the next two years: $8.2 bln in 2003 and $2.5 bln in 2004. Second, the firm conceded that balance sheets have never been as extended as they are now with debt/cap ratios averaging 95%. And third, Merrill Lynch added the industry has a ways to go before it is healthy again. Be that as it may, Alaska Air (ALK 19.53 +1.82), Continental Airlines (CAL 11.95 +2.05), Delta Airlines (DAL 14.76 +1.76), Frontier Airlines (FRNT 7.25 +0.99) and Northwest Airlines (NWAC 10.34 +1.79) were all upgraded to Buy from Neutral. So, what was it in the note that got the market excited? Well, Merrill Lynch said it appears the worst may be over for the airlines, that industry capacity is likely to be somewhat constrained for the next 1-3 years, that the industry restructuring is well underway, and that it feels the bankruptcy threat, at this juncture, has diminished for most airlines. Briefing.com, for its part, upgraded the airline sector nearly a month ago due to favorable developments that suggested an improvement in industry fundamentals. In particular, we pointed to the success in the war with Iraq, the drop in oil prices, and material cuts in labor costs. However, we tempered our enthusiasm in recognition of the fact that the industry's sizable losses still make the airline stocks better trading vehicles rather than investment options. As for Merrill Lynch, it thinks the stocks could break out of the trading range they have been confined to since the fall of 2002. Additionally, it feels that the risk to its 2003 earnings forecasts could be to the upside rather than the downside. If that comes to fruition, it would run counter to the constant earnings reductions for the past several years. On that front, there seems to be room for optimism, but before getting too carried away, keep in mind that all that means is that there could be lower losses rather than bigger losses. To be sure, we doubt Warren Buffett would be fired up by the thought of investing in a stock simply because the company might lose less money. The lack of earnings, though, often gets lost in the dealings of a momentum-driven market, but in the end, it is earnings growth that is the foundation for long-term capital appreciation. Sure, we know the market is buying into the idea that the airline industry is headed back in the right direction in that respect, but its growth trajectory right now means losing less rather than earning more-- and that doesn't excite us at this juncture when looking at things from an investment perspective.-- Patrick J. O'Hare, Briefing.com