Does The Surge In These ETFs Signal An Airline Recovery?

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January 14, 2013 2:28pm NYSE:FAA NYSE:JJC

Both the exchange traded fund for airlines, Guggenheim Airlines (NYSEARCA:FAA), and the exchange traded fund for oil, United States Oil (NYSEARCA:USO), are soaring at the same time.  That is a bullish trend for day traders as there is a traditional inverse relationship between the USO and the FAA. 

With each flying higher, that could signal that the airline industry is finally recovering.

Fuel costs are about 40% of an airline’s total expenses.  When oil rises in cost, the airline industry is one of the hardest hit sectors and among the first to feel the impact.  Due to intense competition in the sector, it is very difficult to pass higher fuel costs on to passengers.  There are also high fixed costs.  Hedging can offset some of the burden, but that does not always work.  To save on fuel, airlines have implemented a myriad of measures; from taxiing with only one engine running to having motor vehicles push them around as much as possible while on the ground.  The chart below shows the inverse relationship between the FAA and the USO over the last year of market action:

But has the table below reveals, in recent trading, the FAA and USO have been trending in a co-relationship.

Share Price Week 1.23% 0.53%
Share Price Month 14.51% 8.23%
Share Price Six Months 19.17% 5.35%

Source: Finviz

The share prices moving together now provide vital information for day trading.  First and most important, the inverse relationship is currently gone for a variety of factors.  The airline industry has implemented a new business model based on increased fees that has generated much more income.  This has been very successful for Spirit Airlines (NASDAQ: SAVE), which is the most profitable carrier in the United States.  The fee income is basically responsible for most of, if not all, of the improved earnings.

Next is that consolidation in the industry appears to be working.  There are fewer seats available after mergers included United (NYSE:UAL) and Continental, and Delta and Northwestern.  Southwest Airlines (NYSE:LUV) acquired AirTran.  If American Airlines and US Airways (NYSE:LCC) merge, that will further reduce the completion in the industry.  Delta (NYSE:DAL) is also grounding Comair, as American Airlines is its regional carrier.  That will allow for higher priced tickets, generating more earnings for airlines.  From that will be rising share prices in the sector, including the FAA.

Due to domestic political considerations in OPEC nations, it appears as oil in the $100 range will be the floor.  The airline industry is doing well, so that indicates that it has adapted to fuel at that price.  If oil swings away from that range, due to greater production driving down the price or some event sending it higher, the FAA might not react as before.

During The Great Recession, oil fell from around $150 a barrel to about $50.  Despite the huge discount in fuel, airline stocks still plunged.  So the relationship was not always perfectly inverse.  However, due to consolidation in the industry, greater economic demand that will send the USO higher could also send the FAA up along with due to consolidation in the industry higher revenues from the new business model.

Day traders should look for other exchange trade funds that are sensitive to fuel, such as that for shipping, Guggenheim Shipping (NYSEARCA:SEA), or to economic demand, like copper, iPath Copper (NYSEARCA:JJC).  The movements on those ETFs will add more confirmation to the directions that the FAA and USO are heading.  As the SEA is up in recent trading, that is very bullish support for the rises of the FAA and USO based on fundamental economic demand due to growing commercial activity increased demand for the goods and services of the transportation sector.

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