Analyzing This "Odd Couple" of 2020

There is a distinct correlation between the airline and bank sectors in 2020

Editor-in-Chief
Oct 2, 2020 at 10:54 AM
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As the U.S. digs out of the economic mess wrought from the coronavirus pandemic, there have been and will be countless new market phenomena occurring worth studying. A macro-event like this that has gone on for most of 2020 is bound to create odd little quirks and correlations worthy of closer examination. One such "odd couple" has been the correlation between airlines and financials.

To start, let's take two well-regarded individual equities from the respective sectors; United Airlines Holdings Inc (NASDAQ:UAL) and Wells Fargo & Co (NYSE:WFC). The former is down roughly 64% year-to-date, while WFC has taken a 57% haircut in 2020. And both stocks are struggling at psychologically significant market cap levels; UAL hasn't been able to hold $10 billion, while Wells Fargo struggles with the $100 billion market cap. The price action of the equities look identical when laid down on the same graph; the sharp coronavirus-fueled drop around March, a spike during the summer that led to consolidation and sideways trading, and now a pivot lower amid the September selloff.

There are numbers to back up the eye test. As you can see below, UAL and WFC's 10-day correlation is above 0.80. That coefficient is used to measure the pattern between two securities. For example, when two stocks move in the same direction, the correlation coefficient is positive. Conversely, when two stocks move in opposite directions, the correlation coefficient is negative. Save for a brief late-June period, that correlation has stayed positive the entirety of the coronavirus pandemic.

WFC UAL Small

But it's not just an odd coincidence between two unrelated stocks. The chart at the bottom runs the same scenario through the broader Financial Select Sector SPDR Fund (XLF) and the NYSE Arca Airline Index (XAL). The similarities remain, as does the positive 10-day correlation. The only difference has been a slight dip into negative correlation territory – meaning XLF and XAL were moving in the opposite direction – prior to the September selloff. Looking closer, it appears it was the airline sector that kept climbing while bank stocks took a breather.

The similarities don't stop with technicals, either. Looking at XLF and XAL's 14-day relative strength reinforces what the chart shows. Both the financial and airline sector sit in the 40% bracket, indicating a bearish status and trending toward oversold territory. And that's not even to mention the options pits, where call traders dominate the picture and have for some time. In the last two months, WFC calls have outnumbered puts by a four-to-one margin, while UAL calls outpace puts by a healthy two-to-one margin. These respective 50-day call/put volume ratios at the International Securities Exchange (ISE), Cboe Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX) also rank in the 95th percentile or higher of their annual range, indicating an unusually heavy appetite for long calls of late.

Plus, WFC and UAL sport attractively priced premiums at the moment. Their Schaeffer's Volatility Indexes (SVI) of 49% and 80%, respectively, both sit lower than the bottom 25th percentile of readings from the past year.

As we hurtle toward one of the more seismic market-moving events in recent years, investors should leave no stone unturned when looking for the next trading opportunity. While this correlation between airlines and financials is in no way a bullish or bearish signal, its another trend that should be monitored closely as volatility gets ready to strike another blow to 2020.

Small COTW

Subscribers to Bernie Schaeffer's Chart of the Week received this commentary on Sunday, September 27.


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