Freight Indices Steam Toward Recovery

How Now, World Dow?

The obvious candidate for the external force is the global equity market. It's linked both to the safety premium in bonds and (allegedly) to the overall level of global macroeconomic activity. Let's compare how the Baltic freight index and the Dow Jones World Stock Market Index have tracked each other over the past decade.

Motion on the Ocean

Source: Bloomberg

The answer: surprisingly poorly. The Baltic freight index's abrupt move higher in 1994 and early 1995, a period highlighted by the Fed's seven rate hikes, a bond market massacre and the first and only economic "soft landing" in recorded history, came with no real advance in the Dow world index.

Of course, those rising interest rates had something to do with it. The fact that equities went nowhere during a period of rising rates had to mean that expected earnings were rising just as quickly.

Ships and Chips

The Baltic freight index dropped fairly rapidly from mid-1995 to late 1996, a period coinciding with the takeoff of the late-1990s megabull market. The world's central banks, led by the oh-so-brilliant Bank of Japan and our very own Federal Reserve, were pumping out liquidity. This led to financial inflation without a corresponding surge in ocean freight demands. The real growth was in information technology and telecommunications, and you can ship a byte on a beam of light.

Not until the eventual resolution of the various Asian/Russian/Brazilian/Clinton crises did the Baltic freight index move higher in pace with the world's stock markets. The freight index started to fall in late 2000, just after the last attempt to recover from the bursting of the bubble in the spring of that year.

The freight index's present (irrational?) exuberance hasn't been mirrored yet in the world's stock markets. After all, we've been getting pounded for close to three years at this point, and it's certainly reasonable to expect skepticism on the part of depleted investors. Simple fear is the most likely reason that neither stock prices nor bond yields have confirmed, to steal a phrase from Dow Theory, the freight index's rise. Other indicators, however, are pointing toward a strengthening economy and a lower risk of deflation.