Every day for the last 18 months now, markets have moved based on trade sentiment. Whether or not President Trump and Chinese President Xi Jinping decide to come to terms on trade influences whether or not the S&P 500 rises or falls, and that’s certainly become the case in recent days as the two leaders prep for their meeting at the G20 summit later this month. The trade news has boosted the index by 1.4% this week alone.
But economists strangely still track the same common metrics while these new trade developments continue to dominate the market narrative. Indicators like consumer confidence and monthly employment figures are helpful but mostly only within the confines of U.S. borders – they don’t account for the reality that the world’s largest economies may impose tariffs on one another or just not ship goods altogether out of spite.
That’s where the obscure Baltic Dry Index (BDI) comes in. This index essentially measures the trading activity of the world’s most commonly used goods – particularly grain, coal, iron, and other building materials – by tracking the routes of Capesize, Panamax, and Supramax cargo ships. The BDI is a prime indicator of economic growth and production because, instead of tracking ships carrying produced goods, it only tracks ships with precursors to produced goods.
On the simplest economic level, the BDI measures supply and demand on a global scale. When the BDI falls, it reflects falling global commodities sales and shipping prices. Since shipping is the main indicator of whether or not countries want goods, lower shipping prices can signal a weakening economy. After all, countries buy more goods when their economies are stronger and they have more money.
Despite being easy to understand, many investors and economists remain hesitant of the BDI’s relevance in the modern era. And for the most part, these detractors came to the forefront in the aftermath of the financial crisis…
Argument Against the Baltic Dry Index
The simultaneous collapse of world economies in 2008 led to an excess supply of cargo ships. Budget deficits meant a lack of trade interest, which led to thousands of these ships having to sit dormant. They were mostly filled with raw materials that stayed at their ports because the exporting countries didn’t trust the credit of the importing countries, resulting in a standstill that both distressed shipping companies and collapsed the BDI. While major firms like Maersk, DryShips Inc. (DRYS), and Frontline Ltd. (FRO) neared financial ruin, the BDI plummeted a stunning 93.9% from 11,648 to 711 between May 2008 and December 2008.
But the index was losing its appeal even as the economy recovered, primarily due to China. The nation’s cargo ship capacity skyrocketed, with many estimates indicating it doubled between 2010 and 2013. That consequently caused the global number of cargo ships to nearly double.
Because of this big supply injection of vessels, economists haven’t been able to properly recalibrate the index. Since China tends to keep its economic reports hazy or under wraps, it’s hard to say how many new ships were built during that three-year period earlier this decade. That means the BDI may not be accounting for thousands of ships around the world.
Argument for the Baltic Dry Index
Despite these drawbacks, some investors have renewed their interest in the BDI recently, especially as its rebounded 162% from about 450 points in early 2016 to 1,179 points this month. As previously mentioned, market participants still embrace the index because it tracks the commodities that are most fundamental not just to society but also to the upkeep of society.
Additionally, the BDI operates in a way that the stock and bond markets, for example, never can. Those two markets are fueled by bets on company earnings, interest-rate decisions, and a multitude of other nebulous factors. On the other hand, speculation is completely absent from the BDI’s calculations since countries don’t book cargo ships unless they have actual cargo to move.
Looking Ahead
While the BDI has experienced long-term growth, its short-term performance is a different story. It’s down just over 8% since the start of 2019 due to broad volatility in the commodities sector, and this volatility will likely continue if President Trump and President Xi Jinping don’t come to an agreement on trade terms soon.
That being said, views of the BDI’s significance vary by investor. Many who keep an eye on international markets and assets may find the BDI more relevant to their investing goals, while those who prefer to play the S&P and Dow Jones may not care for the index.