The Baltic Dry Index is a metric fundamental analysts use to forecast the health of the global economy. Over the past month, the index has tumbled by a whopping 60%.
In turn, a number of news articles say that this chart reveals what's ahead for U.S. stock prices and the global economy. But does it really signal a stock crash and economic calamity?
Source: Bloomberg
When charts like this one are in the news, we often receive questions about them via the
EWI message board.
Yet when we're asked, "How does the BDI fit in with our Elliott wave analysis?" our short answer is:
It doesn't.
There's an old saying among journalists that goes, "If your momma tells you she loves you, check it out." And that's exactly what we advise in the case of the BDI.
A closer look leads us to ask and answer two crucial questions:
- Is the BDI as significant a leading economic indicator as fundamental analysts claim? And …
- Has history shown a consistent correlation between the BDI and the U.S. stock market and/or economy?
These are the questions any market analyst and trader worth his salt must answer before acting on this seemingly mega-bearish fundamental news.
We turned to our market analysts here at EWI for answers.
"The Baltic Dry index is a fundamental measure of [past] economic activity. Therefore, don't expect it to forecast future market direction," says European Short Term Update Editor Chris Carolan. "From January 2008 to mid May 2008, for example, the Baltic Dry index rose 128%. It certainly didn't forecast the subsequent worldwide crash."
So does the Baltic Dry Index have any significance as a leading indicator for the world economy or stocks?
This chart reveals the answer.
Source: Bloomberg
The Baltic Exchange Dry Index peaked in 1994 and declined all through 1998, just as the world stock markets and economies zoomed upward in the Internet mania of the late 1990s – this demonstrates a negative correlation with stocks and the economy.
But in 1999-2000 the BDI rallied with stocks, while in 2000-2001 it fell as the Internet bubble burst – this demonstrates a positive correlation. In late 2001-2003 it rallied, but was way ahead of the rally in stocks that began in March 2003 – a negative correlation. In 2004-2005 it fell while global stocks posted 20-60% gains – a negative correlation. Since 2006, it usually rallied with stocks – a mostly positive correlation.
This chart shows that over the past decade, the BDI has had no consistent correlation to stocks and the economy. Therefore, it is not a reliable leading indicator to forecast stock prices or the direction of the economy. However, like other bits of fundamental analysis, it can provide a supporting after-the-fact measure of what has already occurred.
So what can you look at instead?
"Recent articles have made the claim that the Baltic plunge indicates an imminent economic collapse. Maybe the economy will fall apart suddenly, but it won’t be until stocks start a major decline," says Elliott Wave Financial Forecast Editor Steve Hochberg. "And it won’t be because the Baltic is plunging."
In other words, there's a big difference between supporting analysis and leading analysis. Only leading analysis can help predict future stock prices or the health of the economy. The Baltic Dry Index falls short of this goal. The BDI is a typical piece of fundamental analysis, because it's an after-the-fact picture of performance. It works as a leading indicator until it doesn't lead anymore.
In truth, all fundamental analysis is after-the-fact. Its only value is to show you what has already occurred.
Elliott wave and other forms of technical analysis actually help investors anticipate the trends by revealing recognizable patterns that have proven time and again to lead to significant price action in the future. Using these tried-and-true methods of analysis, EWI's services can help you get a leading edge on the markets you currently follow.
Our latest global analysis is a great place to start.
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