Baltic Dry Freight Index Indicates Impending Recession

Includes: DIA, IVV, SPY
by: Bespoke Investment Group

Every once in a while, an economic term or indicator that was previously not widely followed finds its way into the mainstream financial conversation. Before the Fall, if you had asked nine out of ten people what the TED Spread was, we don't even want to guess what the typical response would have been. Once the credit crisis accelerated though, this was the indicator that everyone was watching to guage the stress in the system. Now that the TED Spread is back to approaching more normal levels, we suspect that it will go the way of Spuds MacKenzie.

One indicator that seems likely to replace the TED Spread as the indicator du jour is the Baltic Dry Freight Index. While many readers may be familiar with the term, for those who aren't, the Index measures the cost of moving raw materials by sea in container ships. Many economists consider the index to be a good leading indicator of economic activity, because if not as many people are looking to move cargo, ships will be in less demand, causing a drop in the price that shippers can charge.

For many economists, recent declines in the Baltic Index have reinforced views that the economy is not only weakening, but heading into recession. While the 37% decline since mid-November makes good headlines, some perspective is needed. Using data going back to 1985, there have been nine other periods where the Baltic Index declined by 35% or more. Over the same period, the economy has slipped into recession only twice. So while the Baltic Index typically declines leading up to or during recessions, declines in the index do not necessarily mean that a recession is on the horizon.

The chart below shows the performance of the Baltic Index since 1985. At first glance, the chart is reminiscent of the Nasdaq in 2000 or a homebuilder stock in 2005. Whether or not the Baltic Index is a bubble that has now burst is up for debate, but we would note that part of this sharp increase can be linked to China's entrance into the WTO on December 11, 2001 (red line).