Contrarian's Delight: Betting on Transports

If oil peaks, airlines and shippers could come back in favor. Some are already anticipating it.
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Oil hit another all-time high Wednesday, so it must be time to get back into transports.

Crazy as that sounds, it may be a good short-term trade, says Jeffrey Saut, market strategist at Raymond James. He thinks oil is nearing a short-term peak, which could be followed by a correction. That's also the view at Ned Davis Research, which cites investor surveys showing 81.3% of those polled are bullish on oil.

Crude oil prices may have to test $70 per barrel before they retreat, Saut believes. But when they do, and if crude falls below its 50-day moving average at $61, some bets in the sectors traditionally hit hardest when energy prices rise could pay off.

"If the call on oil is correct, you might consider going long into the transports and the airlines," Saut says. "Especially the airlines, because they have been so beaten up."

As oil prices surged from around $58 to close to $67, the Amex Airline Index fell 11% from 53.37 to 47.36 from July 20 to Aug. 12. The index rebounded some as oil prices retreated in mid-August but it has again lost ground with oil climbing back above $67. The index was recently trading up 0.7% at 48.86.

Saut recommends

Southwest Airlines

(LUV) - Get Report

or

JetBlue

(JBLU) - Get Report

. But he thinks that

Northwest Airlines

(NWAC)

has already had its run, benefiting from

hedge fund interest after getting crushed when its mechanics went on strike.

Morningstar airline analyst Chris Lozier says the impact of oil prices on airline profits -- and their stocks -- has been tremendous, given oil's largely unexpected rise.

"We can't really blame them for not hedging against

oil prices. Who among oil analysts were expecting early this year that crude would be close to $70 now?," Lozier asks. Southwest has been the only airline that successfully hedged, paying $26 per barrel this year, and securing fuel in the low $30s for next year. Not coincidentally, perhaps, Southwest is the most profitable airline.

Beyond airlines, a short-term call based on oil is harder to make for the transport sector as a whole. "A lot of the risk has been taken out of the airlines because of the flop they've had," says Saut. But while the Dow Jones Transportation Index has very often traded in synch with oil prices, that trend has been fading of late.

The Dow Transports fell 0.5%, from 3769.46 to 3747.97 between July 20 and Aug. 12. Since then, the index has fallen another 1.5%, trending lower with the broader market. The index had been underperforming the

S&P 500

since late April, but has been catching up to the broader market since late June, and trading in synch with it since early August.

Optimists believe the index may be poised to resume the outperformance that characterized the past 12 months. On Thursday, the Dow Transports was recently up 0.6% while major averages hovered just above break-even. On Wednesday, the index gained 0.1%, while the

Dow Jones Industrial Average

tanked as oil closed at a new all-time high of $67.32.

Many of the non-airlines companies in the index -- such as

FedEx

(FDX) - Get Report

and

UPS

(UPS) - Get Report

-- are well hedged against surging oil prices. They pass on higher energy prices to their customers through special fuel surcharges. Many other transport stocks have gone a long ways in improving their energy efficiency by using new technologies.

"When there's a sudden fuel spike, they might eat it for a couple of weeks, but their surcharges catch up and it remains minor," says Morningstar transport analyst Nick Owen.

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But rather than a one-time surge, oil's long, steady rise is now threatening to affect the overall economy and the affliction goes beyond just transports. That's why whether it's the airlines or the transport sector, these calls based on oil are purely short-term and for traders only, Saut warns. "Over the long term, I don't want to own the airlines," he says.

In keeping with TSC's editorial policy, Godt doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He appreciates your feedback;

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