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Where's the Economy Headed? Insiders Watch This Key Index

The Baltic Dry Index, not exactly a phrase that rolls off an investor's tongue, is signaling plenty of caution these days about the global economy.

A container ship from Korea sits at a loading dock at Seattle's Harbor Island near downtown, Thursday, May 11, 2006. The U.S. trade deficit unexpectedly declined in March for a second consecutive month, something that hasn't happened in more than two years. The improvement reflected record U.S. exports and a big drop in the country's foreign oil bill. (AP Photo/Elaine Thompson)
Elaine Thompson
A container ship from Korea sits at a loading dock at Seattle's Harbor Island near downtown, Thursday, May 11, 2006. The U.S. trade deficit unexpectedly declined in March for a second consecutive month, something that hasn't happened in more than two years. The improvement reflected record U.S. exports and a big drop in the country's foreign oil bill. (AP Photo/Elaine Thompson)

As a gauge of shipping activity along 20 of the world's busiest routes, the BDI is a leading economic indicator used by market insiders to gauge demand for goods.

But while it remains a somewhat arcane measure, the recent sharp drop in the index has drawn increased attention, despite the dramatic rise in US equity markets and the accompanying hopes for economic recovery.

"It's not the leading barometer that's going to make you move all your money. But with a host of other indicators, it's important, particularly when it comes to China," says Quincy Krosby, general market analyst with Prudential Financial. "That's where the linkage fits in."

It's been a rough summer for the index, which is not a measure of activity in the Baltics but rather an instrument that traces its name to 1744 and the Virginia and Baltick coffeehouse in London's financial district. The index is weighted toward activity in the Pacific.

The BDI has tumbled about 43 percent since peaking on June 3. That followed a stunning upturn off a low of 663 on Dec. 5, 2008 to the June 3 high of 4,291.

Since then, China's economy has struggled and its Shanghai stock index has dropped 16 percent since the beginning of August.

For some analysts, the shipping index's plunge is indicative that the slowdown in demand for shipping will mean more troubles for the US economy, despite its recent signs of growth that have led some to call the recession over. Thus, the increasing popularity of the BDI as a yardstick.

"The reason it's becoming more popular is it has been a very accurate indicator of recessions," says Tony Sagami, editor of Weiss Research's Asia Stock Alert newsletter.

Sagami sees the BDI drop as showing a fall in metals prices, which generally portends an economic slowdown; signal of a short-term correction in the Chinese markets; and a sign that the global economy remains in trouble.

"The US is headed for a Japanese-style recession," says Sagami, who recommends investors increase cash positions.

Economists developed the BDI in part as a buffer against historically dubious economic data from China. The country's numbers are chronically inaccurate, so analysts often look to more objective data such as energy consumption to measure economic activity in China.

With the country planning soon to celebrate the 60th anniversary of the Communist takeover, there have been questions raised over what measures the government might take to bolster the stock markets so as not to dampen the festivities.

"They hope to make it a super celebration, maybe better than the Olympics. But swirling numbers of unemployed may rain on that parade," Art Cashin, director of floor operations at UBS, wrote in his daily market commentary. "Some think the government could be induced to shore up the stock market to shore up morale as the anniversary nears. They can shore up the market all right, but can they shore up the Baltic Dry Index?"

To some investors, though, the changes in the BDI won't slow down the US recovery.

Some of the downswing is likely attributable to a typical slow summer. Prudential's Krosby says the low numbers now will only matter if the index continues its slump into mid-September, when activity in both the economy and stocks is expected to accelerate.

The index also is notoriously volatile.

"The Baltic Dry Index is very much a function of perceptions about China. There's this prevailing wisdom that China's going to level off here," says Michael Cohn, chief investment strategist at Atlantis Asset Management in New York. "It's worth watching, but I don't really think it's having that much effect here."

Indeed, the US stock indexes have been having a field day while the BDI has been going into the tank.

Mild downturns like the stock movement Wednesday have been met only with more buying, as portfolio advisors and money managers who missed the early part of the five-month rally have been scrambling to find any buying opportunities in the current market.

Yet there also remains sentiment that some type of correction is coming, and the BDI is being seen as a flag for possible trouble ahead.

"Come the end of September, October, we would want to see the Baltic move up. We would not want to see that continue to drop," Krosby says. "It would be one of those barometers that would question the global recovery thesis."