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By David Berman

It’s easy to scoff at airline stocks – and I have been guilty of doing this – due to volatile earnings, slim margins and high chances of slipping into bankruptcy protection. But if you want a clear example of how many cyclical stocks are outperforming their defensive brethren this year, look up in the sky.

No doubt, consolidation is fuelling some of the interest in stocks, as investors bet that bigger airlines will do a better job of cutting costs. Southwest Airlines Co. (NYSE:LUV) made headlines on Monday morning with its deal to acquire AirTran Holdings (AAI) in a deal valued at $1.4 billion (U.S.). Even though Southwest is the acquirer here, investors drove the stock more than 9% higher in late-morning trading. For 2010, the stock is now up 16%, and for the past 12 months it is up 38%.

The airline isn’t alone with outsized gains. Continental Airlines Corp. (CAL) – which is days away from closing a merger with UAL Corp. – has risen 36% this year and 45% over the past 12 months. Delta Air Lines Inc. (NYSE:DAL) is up 27% over the past 12 months and US Airways Group Inc. (LCC) is up 91%. Even Air Canada (OTCPK:AIDIF) has participated in the rally, rising an amazing 117% this year.

The trick with investing in airlines stocks, of course, is to avoid the temptation of holding onto them for too long – given their tendency to over-describe fears about the economy and fuel prices. So far, analysts appear to see clear skies ahead: Nine of the 10 analysts following Air Canada have a “buy” recommendation on the stock. None recommend it as a “sell.”

Perhaps the best argument in favour of holding on is the fact that most airline stocks are still shy of recent highs. After all, these stocks were creamed during the worst months of the recession, and only some are approaching their pre-recession levels. Air Canada is an exception: Despite its recent rally, the shares remain about 90% below their 2006 initial public offering.

Disclosure: None

Source: Airline Stocks: Up and Away?