I say so for a simple reason. Since 1990, there has been a statistically significant negative correlation (of minus 0.34) between the level of the Baltic dry index and the subsequent 12 month change in the All-share index. The Baltic hit a record high in May 2008, just before shares slumped. It also peaked in 2000, just before shares fell. And it rose strongly in 2013, but shares fell slightly in 2014. By contrast, low levels of the Baltic index in 2005 and 2011 led to shares doing well in the following 12 months.
If the post-1990 relationship between the Baltic dry and subsequent annual change in the All-share index continues to hold, the All-share will rise by over 10 per cent in the next 12 months, with only around a one-in-four chance of it falling.
One reason for this negative relationship might be that shares over-react to the state of the world economy. In good times - when high economic activity is raising shipping costs - shares get too high, and in bad times they get too low.
But there’s something else. The Baltic dry index is also a good negative predictor of growth in UK manufacturing activity: since 1990 the correlation between the two has been minus 0.41 (and minus 0.44 since 2000). This suggests that low transport costs will lead to stronger economic growth.
There’s a simple reason for this. Shipping costs might seem very unglamorous, but they matter enormously to the world economy. A fall in them has surprisingly powerful effects in boosting trade and hence output. “Freight costs have a statistically significant and quantitatively important impact on trade flows” concluded Alberto Behar and Tony Venables of the University of Oxford in one study. This is one reason why landlocked countries tend to be poorer than ones with sea borders: Switzerland is pretty much the only exception. And Maurice Obstfeld and Ken Rogoff have argued that trade costs can explain otherwise puzzling features of international economics, such as the Feldstein-Horioka puzzle - the fact that countries can’t run large sustained current account imbalances.
A low Baltic dry index might be a symptom of low demand now. But basic economics tell us that low prices also stimulate demand , so we could see a pick-up in world trade soon. Given that there’s a strong correlation between world trade and equity returns, this should be good for stock markets.
There are of course caveats to this. The Baltic dry index is very volatile and a correlation of minus 0.34, whist better than zero, isn’t enormously strong. And there are longer-term reasons why world trade might stay subdued - such as worries about the difficulty of managing global supply chains and fears about the future availability of trade credit. Nevertheless, if the low level of the Baltic dry index is sending any signal at all (which isn’t certain given its volatility) that signal is a bullish one.
