'But why drives on that ship so fast, Without or wave or wind ?'
from "The Rime of the Ancient Mariner"
The Baltic Dry Index (BDI) is a measure of shipping rates paid to move ocean freight worldwide. Since it measures paid prices the index reflects real economic activity: it is not an index based on opinion, speculation, greed or fear. Its trend is therefore a useful yardstick against which investment market levels can be judged.
Traders of US 10-year Treasury notes have usually forecast economic prospects as reflected by the BDI correctly. Indeed, 10-year Treasury yield data has led the BDI with two exceptions in the last decade. The first of these began in the summer of 1995 when (unshippable) telecoms and IT equities sailed forward on a sea of Fed liquidity despite a falling BDI; and the second began at the trough of the market fall in spring 2003 when investors were fearful of buying equity - even as the BDI shot up.
It may be time to write-up a third divergence. At end February 2005 the BDI and the 10-year Treasury appeared to part company.
Exhibit A: BDI and Ten-Year Treasury Yields - you take the high road
With the BDI at the time of writing at 2,407 it is still at heights unscaled before 2003. However, if it goes below 1,750 with conviction - and it was at 1747 this summer - the index will simply be reverting towards its long-term mean. This is not merely technical-analyst talk: there are sound reasons why this is likely, covered here by the Economist magazine.
Treasury yields, meanwhile, have been insensitive to these developments and are continuing to reflect - perhaps above all - just how much cheap money is sloshing around. Nonetheless, for the businesses and sectors exposed one way or another to shipping activity the outlook is distinctly gusty to gale-force:
Exhibit B: BDI and Clarkson Plc, the world's largest quoted shipping broker
Clarkson Plc is an excellent company in which this scribe owned equity until earlier this year. Why sell? Because the trend of this graph suggests that investors in companies exposed directly and indirectly to shipping markets (or both, as in Clarkson's case) have continued to buy into the boom story (China, commodities, emerging market strength et al) even as demand for freight services tapers away.
Does this herald a fall in world stock markets? In itself, no. Yet it is certainly not a good sign that aggregate demand for shipped goods and raw materials is dropping sharply. Markets do not seem to be paying attention so far: the example above of Clarkson plc is a proxy of a more general observation. However, as in 1995, it is always possible market leadership may come from sectors unconcerned with freight rates and activity. But that would be a courageous and potentially expensive passage for investors to book.
Happy New Year.
Credits: The 10 year Treasury / BDI background (para 2) comes from a 2002 article by Howard Simons.