The airline sector has performed well over the last two months, in fact, from July to August the AMEX Airline Index (symbol: $XAL) increased from $13.69 to $26.15, up 91%. To be sure, the index did not escape the market turmoil in September and October, but it did manage to remain above the July lows. This relative outperformance could be attributed to falling jet fuel prices.
In 2008, jet fuel prices and the AMEX airline index have had a correlation of 0.62. This implies that roughly 62% of the time that jet fuel prices fell the airline index rose. Over the last two months (September to October) jet fuel prices have fallen 35%, while the airline index has also fallen 6%. Based on inferences from the correlation analysis, it appears that the last two months are part of the 38% of the time, when the airline index does not trade inversely to jet fuel prices.
However, since October 10, the airline index has gained 49%, while jet fuel prices have fallen 16%. A possible explanation is that the airline index was a victim of the market turmoil and is beginning to adjust to lower fuel prices.
The major airline companiesâ€™ equity prices have held up well relative to the S&P 500 over the last six months. In fact, all except for Southwest Airlines (symbol: LUV) have positive relative strength vs. the S&P 500. Southwest Airlines aggressively hedges fuel costs and therefore the relative underperformance may be the result of its lack of sensitivity to falling fuel prices.
Relative Strength vs. the S&P 500
Â Symbol  4 wk  13 wk  26 wk  52 wk 
AMR  25.38%  49.24%  58.86%  10.31% 
41.34%  88.75%  46.95%  10.93%  
DAL  58.50%  85.51%  88.53%  15.15% 
JBLU  39.33%  37.26%  64.96%  2.68% 
LCC  77.28%  155.64%  69.70%  41.17% 
LUV  0.54%  3.07%  27.82%  33.21% 
UAUA  103.71%  130.99%  33.73%  51.84% 
Source: TradeStation 




The relative strength table illustrates that Southwest Airlines has underperformed the S&P 500 during the recent fall in jet fuel prices. The 52week relative strength figures indicate that the rising jet fuel prices over the last year could have hurt the performance of airline stocks.
The inference that one may be tempted to draw is that prices of airline stocks should rise further if jet fuel falls further. However, there are two flaws in that line of thinking. First, correlation does not necessarily imply predictive ability. In other words, it could just be a coincidence that jet fuel prices and the price of the airline stocks are correlated. Second, the economic environment must be taken into consideration. A falling gross domestic product [GDP] certainly cannot bode well for the prices of airline stocks. Performing a regression analysis will add an element of certainty to the inferences.
Beginning with jet fuel prices, the regression analysis can determine if the price of the airline index is a function of jet fuel prices. Analyzing the daily closing prices of jet fuel and the airline index from January 1995 to October 2008 yielded the following results:
Regression Results of AMEX Airline Index Price on Jet Fuel Price
 Coefficient  Pvalue 
Jet Fuel  0.38  0% 



R Squared  .3931 

Adj. R Squared  .3929 

The analysis indicates that movements in the price of jet fuel can explain 39% (R Squared) of the movement in the AMEX airline index. Furthermore, the Pvalue of 0% indicates that there is virtually no chance that the price of jet fuel is unrelated to the price of the airline index.
Moving on to the GDP quarterly data that was used, the average daily close over the quarter was used for the quarterly price of the airline index.
 Coefficient  Pvalue 
Qtr. Change in GDP  5.40  9.15% 



R Squared  .0528 

Adj. R Squared  .0349 

The results of the GDP analysis suggest that only 5% (R squared) of the price change in the airline index can be explained by changes in the GDP. Further, there is a 9% chance that GDP has no relation to the price of the airline index. These results suggest that GDP growth, or lack thereof, should not be a concern to airline investors.
Combining the two variables (change in GDP and Jet Fuel Price), produces results that further question the relevance of GDP.
Regression Results of AMEX Airline Index Price on Quarterly Change in GDP and Jet Fuel Prices
 Coefficient  Pvalue 
Qtr. Change in GDP  1.36  60.69% 
Jet Fuel Prices  .3792  0% 



R Squared  .4021 

Adj. R Squared  .3791 

Using both variables, the results suggest there is a 60% chance that the price of the airline index is unrelated to the change in GDP. As well, the price of jet fuel does have a statistically significant role to play in the price of the airline index.
The results explain why airline stocks have been rising, while the GDP has been falling or has been expected to fall. In fact, GDP has little to do with the price of airline stocks. While jet fuel prices are not the sole determinant of airline stock prices, they play an important role.
Disclosure: I am long CAL and JBLU