The Baltic Dry Index is, in my opinion, the best leading economic indicator to follow when the media is telling us the economy is looking great one week and then predicting a double dip recession the next. Let me explain.
So says an article* at www.pinnacledigest.com which Lorimer Wilson, editor of munKNEE.com , has reformatted into further edited […] excerpts below for the sake of clarity and brevity to ensure a fast and easy read. (Please note that this paragraph must be included in any article reposting to avoid copyright infringement.) The article goes on to say:
The Baltic Dry Index, also known as BDI, also known as Dry Bulk Shipping, is an index of shipping and trade that measures the international shipping prices of different dry cargoes such as rice, corn, iron, oil etc. Basically, it is an indication of shipping demand against the available worldwide fleet of dry bulk ships. The steelmaking raw material constitutes the largest source of demand for dry-bulk shipping.
One thing to note is the BDI only tracks the shipment of unfinished goods. This is very important to remember and explains why this index precedes market moves and economic moves. Raw goods are used to manufacture finished goods i.e cars, buildings, planes, you name it. If the world is building more planes, cars and buildings, for example, then employment is likely increasing. This is great for the economy and provides liquidity for the stock market via increased retirement investing, pensions, and personal investing (notice I say liquidity and not necessarily rising stock prices… I’ll get to that later).
When the Baltic Dry Index is on the rise, economic activity is either increasing or about to increase. As such, when its rising, it precedes increased liquidity in equities, rising commodity prices, rising interest rates and rising commodity based currencies such as the Canadian dollar.
A key note to remember in all of this is that the BDI is a leading indicator of economic activity but not necessarily a leading indicator of a rising stock market… just a more liquid stock market, due to better economic conditions. So what does that mean? It means don’t buy stocks just because the BDI is rising. In fact, my strategy is quite the opposite. I like to buy stocks in quiet or slow periods and sell into exciting more liquid times.
Historical Behavior of the Baltic Dry Index
The peak over the last 20 years was 12,000 (probably won’t get that high again for at least a decade) in the spring of 2008 when borrowing money was cheap and excess was the name of the game. The 20 year low was hit that same year in December when it touched 663. Not surprisingly, the bottom of the ‘great recession’ was hit shortly thereafter. The obvious signs tell me that if the BDI ever touches 12,000 again, liquidate equity positions as the market will carry way too much risk with minimal upside. If it touches anywhere near 663, I’ll be scrounging up as much cash as I can find and dumping it into the market. However, both these scenarios are very unlikely to happen anytime soon. I’m going to get a bit more realistic in finding entry and exit points in the market.
Over the last ten years the Baltic Dry Index has averaged (roughly) around 2600-2700. Consider that level to indicate average economic activity and average liquidity in the stock market. Take a 30% discount on that average to find an ideal entry point in the market and it gives you roughly 1855. This tells me that when the Baltic Dry Index hits that number I’ll be scrounging up as much cash as I can find and dumping it into the market. However, both these scenarios are very unlikely to happen anytime soon. I’m going to get a bit more realistic in finding entry and exit points in the market.
Over the last ten years the Baltic Dry Index has averaged (roughly) around 2600-2700. Consider that level to indicate average economic activity and average liquidity in the stock market. Take a 30% discount on that average to find an ideal entry point in the market and it gives you roughly 1855. This tells me that when the Baltic Dry Index hits 1855 it is time to aggressively position myself in the stock market, as economic activity is extremely low and likely (history almost always repeats itself) to rebound once inventories of raw goods are eroded (which is inevitable and was a huge reason we saw that monster rally in 2009 – it was a replenishing of inventories).
How to Play the Baltic Dry Index
Anytime the Baltic Dry Index clears 3500, I am thinking about selling, provided nothing too significant has changed in the world economy (30% premium to 10 year BDI average). I believe this to be a very conservative approach to timing the market.
The BDI currently sits at 2440, just below its 10 year average.
If I’m to use the BDI as my sole tool of judging the market (always have more than one indicator), I’m in a hold period, but still looking to buy on weakness.