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Baltic Dry Index: Is This Powerful Indicator Signaling A Global Recession?

Although memories of the Great Recession linger, a case can be made that better days lie ahead.

That’s because central banks around the world are pursuing bold stimulus measures. And the United States is looking solid enough for the Federal Reserve to contemplate its first interest rate hike in nearly a decade.

Moreover, gas prices have fallen sharply, which aids consumers, and the stock market is way up, having nearly tripled from recession lows.

But this is no time for investor complacency: indeed a key economic indicator suggests trouble may be brewing just beneath the surface.

The index in question: the Baltic Dry Index.

As a composite measure of worldwide daily shipping prices for commodities like iron ore, steel, cement and coal, the BDI provides insight into manufacturer demand for the raw materials that, literally and figuratively, form the foundation of the global economy.

Typically, a rising BDI coincides with stronger demand from producers, who’ll need raw materials to generate energy and manufacture a variety of things, from roads and bridges to cars and machinery.

This is what makes the BDI such a compelling indicator. It provides information about core economic activity that has yet to take place.

The thing is, the BDI crashed from 2013 highs and now sits around 30-year lows.

The sheer magnitude of the decline should grab every investor’s attention.

My colleague Dave Sterman recently expressed concerns of the growing likelihood of financial distress for dry bulk shippers , which has broad domestic implications, but I am equally concerned about what it means for the global economy.

While the plunge doesn’t necessarily portend a market crash, know that the BDI has shown persuasive correlations with severe market downturns before. It happened in 1999, just ahead of the 2000 dot-com bust. And in 2008, the BDI plunged a stunning 90% in less than half a year. That move occurred soon before the 2008 stock market rout was fully underway.

If the BDI was able to forecast the worst of the past two market crashes, might the current plunge also signify trouble ahead?

I think it may… but with a caveat.

As Dave Sterman recently noted, “Dry bulk shippers ordered a lot of new ships in 2013, many of which started plying the waters in the past 12 months.” In fact, the industry’s new ship orders more than tripled to 947 in 2013, from 267 the year before, because coal imports were expected to rise dramatically.

When the big increase didn’t occur, the shipping industry was left with a major oversupply problem — “too many ships chasing too little market action,” as David puts it. The oversupply has triggered aggressive, industrywide shipping price cuts. For example, the average daily capesize rate, the charge for ships that carry up to 150,000 metric tons of cargo, is now around $6,600, compared with as much as $20,000 per day a year-and-a-half ago.

A similar trend is underway in the oil industry. There, too, crashing prices have much to do with a supply glut (brought on mainly by soaring U.S. production), and the glut makes it harder to tell how much of the crash is due to falling demand. This dilutes oil’s value as a leading economic indicator.

Because of the shipping glut, something similar is probably happening with the BDI.

That said, the BDI’s plunge is likely giving a strong signal about the demand side of the equation. By now, most investors are well aware of the many drags on demand for commodities. European and Japanese economies are in turmoil, a recession is underway in Russia and Canada and Australia may also be entering into recession.

Many analysts consider China to be the single-biggest factor in weakening raw materials, simply because its economy is now so large. No country buys as much iron ore as China, yet its imports of the commodity are only expected to rise 7.5% this year, the slowest pace of growth in five years.

So despite the large supply component that’s in play, I still think the BDI has an important message about the global economy. It’s probably not signaling the dire economic conditions a 30-year low might suggest, but investors should be prepared for the possibility of the global economy slowing down and perhaps even slipping dangerously close to recession.

Risks To Consider: If I’m right in my assessment of the BDI, then investors could be greatly underestimating the risk of serious losses in stocks, bonds and other financial assets .

Action To Take –> Besides being a useful economic indicator, the BDI has implications for the overall dry bulk shipping industry. It’s a very tumultuous and tricky place to invest right now, so investors thinking of braving the space should re-visit Dave Sterman’s industry analysis. The piece provides a detailed overview and level-headed investment approach. In the meantime, investors should think carefully about the broader ramifications of current BDI readings and consider paring their exposure to riskier assets, particularly stocks.
Source: Street Authority

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