Tuesday, September 8, 2009

Baltic Dry Index as a leading indicator for stocks?

Trader Narrative in Baltic Dry Index continues leading the stock market has this interesting chart below. It states that 'While the Baltic Dry Index is a leading economic indicator, lately, it has been also behaving as a leading indicator of the stock market.' It adds: 'In fact, if you compare the S&P 500 index for the past few years with the Baltic Dry Index (BDI), it would seem that shipping rates have lead the equities from 1 to 3 months in both rallies and tops.'
Baltic Dry Index vs. S&P500
Source: Trader's Narrative

However, while the chart at first sight looks good, it does not provide a convincing story. Rather, the Baltic Dry Index seems to be more closely correlated to commodities:
Baltic Dry Index vs. CRB Index
Source: Bloomberg

As I suggested in Commodities and related markets to fall first?, commodities seem to be falling as the Chinese re-stocking cycle has ended (and with that shipping rates which rose during the re-stocking have eased again). If it is indeed due to less demand amid an ending of re-stocking (or due to increased supply) as opposed to lower end demand amid weak growth, then lower commodity prices as well as the drop in the CRB index are a positive for equities (as they increase the purchasing power of households and reduce costs for corporates in net-commodity consuming economies) while they are also rather positive for government bonds amid lower inflation pressures. In turn, the drop in the Baltic Dry Index would also explain the diverging performance of bond yields/commmodities on the one side and equities on the other and does not necessarily need to be associated with lower equity prices. Therefore, we can not yet tell whether indeed the significant drop in the Baltic Dry Index is a warning signal that stocks are about to fall or whether this is yet another positive (amid lower costs for shipping and for commodities) for the economy and therefore stock markets.

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