Transports at Crossroads

Airline stocks were weak Thursday even as crude fell $1.14 to $54.23; the Amex Airline Index fell 1.9%, led lower by Mesa Air Group (MESA Quote), which posted weaker-than-expected results.

A more fundamentals-based bearish view is that the Dow Transports are faltering because persistently higher oil prices -- even if down from summer highs -- are dragging down economic activity and, thus, reducing demand for transportation services. December profit warnings from YRC Worldwide (YRCW Quote) and FedEx (FDX Quote) bolstered such views. Then on Wednesday, Norfolk Southern (NSX Quote) posted weaker-than-expected results and its CEO said "we're clearly facing a softer economy."

But UPS (UPS Quote) (which reports next week) appears to be benefiting from FedEx's struggles, and Norfolk Southern is the anomaly in an otherwise strong railroad sector, Jim Cramer said in our Wall St. Confidential video on Wednesday. He repeated that view Thursday in the wake of Union Pacific's strong results and also expanded upon his theory that rails are benefiting at the expense of trucking firms, which are being hurt by a lack of qualified drivers and America's poor highway infrastructure.

Furthermore, the overwhelming tone of recent macroeconomic data lately, including December retail sales and non-farm payrolls, shows the economy was building steam at the end of 2006 and into early 2007. Even Thursday's "weak" December existing home sales report included a 302,000 drop in inventory of unsold homes and resultant improvement in the key inventory-to-sales ratio.

The irony of making a bearish case about Thursday's stock market weakness is that it was largely due to rising Treasury yields, which are responding to the aforementioned economic data and a realization the Federal Reserve is highly unlikely to cut rates anytime soon. Indeed, "the bond selloff shifted from the 'no recession' variety, which was deemed favorable to the stock market, to the unfriendly variety related to renewed fears over the Fed" and possible rate hikes in 2007, writes Tony Crescenzi, chief Treasury strategist at Miller Tabak and a RealMoney.com contributor. "This is at the heart of the equity market's weakness today."

In sum, the Transports are a microcosm for the broader market, providing fodder for both sides of the bull vs. bear debate, but the onus remains on the latter to prove the "divergences" are real.