This Leading Economic Indicator Just Hit a 29-Year Low!

by James Faulkner

With many a doom-monger throwing in their two pennies’ worth on the ultra-bearish side of late, one more bearish signal may not make a whole lot of difference. However, this one in particular could be worth paying attention to. The Baltic Dry Index, an economic indicator that tracks the price of shipping dry goods over oceans, has fallen to its lowest level in 29 years. In fact, the Index appears to be in freefall, having fallen by 60% since the start of November 2014. According to some commentators, the collapse of this important leading economic indicator presages future disaster in terms of global economic growth:

“The Baltic Dry Index dropped another 3% today to 590 – its first time below 600 since 1986 and not far from the all-time record low of 554 in July 1986. Of course, the absolute level is shrugged off by the over-supply-ists and the ‘well fuel prices are down’-ists but the velocity of collapse (now over 60% in the last 3 months) suggests this far more than some ‘blip’ discrepancy between supply and demand – this is a structural convergence of massive mal-investment meets economic reality.”

On the other hand, there are those like Tim Worstall who argue that a price fall due to an increase in supply can brings benefits:

“And, of course, that means that shipping around those raw materials is going to be cheaper in the future. That’s a good sign for future economic growth. Other things being equal cheaper transport will mean more trade and this more of that Smithian (or even Ricardian, dependent upon comparative advantage) growth.

It’s Scott Sumner who keeps telling us that we should never reason from a price change. And his point isn’t that price changes don’t mean anything, it’s that we want to know why the price change before trying to reason about it. It could be that a fall in the Baltic Dry means a reduction in demand for shipping. It could be that it means an increase in the supply of it. It would appear that it’s the latter. And other than a few ship owners who might now regret having ordered more ships that’s actually good news, not bad, for the global economy.”

So is this the beginning of a renewed global slump, or are we in for a trade bonanza on the back of low shipping costs?

In fact, the truth is probably rather more prosaic. The world has endured no end of supposedly ‘freak’ occurrences since the onset of the financial crisis: this is the extraordinary world we have created through extraordinary central bank intervention. Yes, there has been – and there will continue to be – mal-investment, but there is an ongoing ‘tug-of-war’ between the malinvestment and the expansionary forces engendered by the central banks. Consequently, it seems more likely that the net result will be a long period of sub-par global economic performance, as we’re becoming used to, checkered by the occasional microeconomic collapse, such as the one presented above.

One shipping-related stock that could be worth picking up on current weakness…

Founded in 1852, Clarkson (CKN) is a venerable old British firm that has established itself as a leading name in its field. The firm’s big breakthrough came in the 1920s when it became exclusive broker to Esso and thereby the biggest tanker broker in the world. It has since transformed itself into a truly global player with a network of offices across five continents, providing an array of financial as well as port services. For a cyclical stock, the firm put in a resilient performance during the global downturn, maintaining and even growing its dividend payment throughout. Diversification has been key, and in November 2014 the group acquired RS Platou, a Norwegian shipbroker and investment bank, for £281.2 million, in a move that will significantly increase the size of the company and move it into marine investment banking and offshore services.

The fall in rates is a notable headwind for Clarkson, but this is offset to some extent by the sharp appreciation in the dollar, the major trading currency of the group. Even after the recent acquisition, the group maintains a strong balance sheet with minimal debt, and the business model is highly cash generative. Clarkson has coped with low shipping rates before, and crucially shipping volumes continue to rise (see chart above). At 2,080p the shares are well below recent highs (2,738p), trade on a prospective P/E of 12.1x and offer a prospective 3.9% dividend yield.