Back in March, I drew attention to a forward indicator that was at that time flashing warning signals for stocks. That indicator was the Baltic Dry Index (BDI), a measure of the prices achieved by shipping companies for raw material freight.
I pointed out at the time that the BDI is a leading indicator, often with significant time-lag, but that it can also often set the tone for stocks around the world in the short term.
Here’s what happened to the S&P 500 in the three weeks following that piece.
The logic behind the belief that there is a connection between the BDI and the prevailing sentiment in the stock market is quite straightforward: If there is strong demand for available cargo space, and therefore higher rates for shipping, it suggests that manufacturers are expecting strong demand and gearing up for just that.
Weakness in shipping prices, on the other hand, is an indicator of a possible global economic downturn.
Of course, it is not quite that simple, and there is the question of timing to consider, but right now, those desperate for any sign of an end to the downturn in stocks can take some solace in the index.
Once considered one of the major indicators for stocks, the BDI has lost its cachet somewhat in the aftermath of the recession, when the index fell dramatically as stocks made their recovery. It is important to remember though that, like all indicators of price, it is subject to the influences of both supply and demand, and in the case of ships, supply is slow to come online.
The declines in the index from 2010 to 2015 seem to have been more about new ships coming into service that had been commissioned during the boom that preceded the recession than a decline in demand. That has presumably worked its way through the system now, a contention supported by what has happened so far this year.
After falling at the beginning of 2018 as stocks declined, the BDI recovered to hit highs during the summer as the market did the same, then started falling from the year’s highs at the end of August, a couple of months before U.S. stocks began to collapse. The other factor that suggests that the Baltic Dry is a more reliable indicator now than early in the recovery is where the focus of traders and investors lies.
The recession was caused by a financial crisis, so it is logical that an indicator of trade and manufacturing sentiment was not particularly influential on market sentiment back then. Now, however, with a market driven largely by concerns about trade and global growth, freight rates can have a significant impact on the mood.
The post-recession disconnection between the BDI and the S&P 500 serves as a warning of the dangers of taking a simplistic view of not just the BDI, but any indicator. In this case, however, there doesn’t have to be a direct, causal relationship between freight and stock prices for the jump in the index over the last week or so to be significant. As I have pointed out on multiple occasions, this market swoon is about fear, not circumstances, and fear can be dispelled just as easily as it can be generated.
We saw that yesterday, when a few calming words from Fed Chair Jerome Powell addressed the market’s other main concern about interest rates and sparked a huge rally. If you add a more optimistic outlook for global trade to that, as suggested by the sharp rise in the BDI over the last week, there is reason to believe that while stock volatility may not be over, sentiment is beginning to shift and we are set to recover before too long.