The Baltic Dry Shipping Index (“BDI”) is a freight cost index published by the London Baltic Exchange. The “Baltic” part of the name comes from the exchange. It does not indicate that the index only includes prices from routes in the Baltic Sea. The index includes data from routes all over the world.

Road in London, November 2020

Baltic Sea Area Map

The exchange is one of the oldest in the world and the shipping industry has always been an important part of economic and financial ecosystems. Shipping is, and has always been, the most important trade infrastructure. About 90% of the world’s physical trading is done by sea. Maritime power is how a small, and not particularly rich or technologically advanced, country in north-west Europe came to dominate the world for hundreds of years. And some of the earliest derivative contracts were insurance policies between Phoenician merchants.

Because shipping is an indicator of economic activity, it seems reasonable that there is a link to the stock market. And, for similar reasons, traders have long believed that the Dow Jones Transportation Index is predictive. Of course, plenty of “reasonable” ideas amount to nothing, and it also isn’t clear that shipping data leads the market.

The first formal, statistical study of this idea was by Gurdip Bakshi, George Panayov, and Georgios Skoulakis in their paper, “The Baltic Dry Index as a Predictor of Global Stock Returns, Commodity Returns and Global Economic Activity” (2012 Chicago AFA Meetings paper).

Using data from 1985 to 2010, they found that the BDI returns have a positive relationship to the returns of stock markets at the monthly and quarterly durations. The markets they looked at included four regional equity indices, 19 developed nation indices, and 12 emerging nation indices. Statistically significant evidence of out-of-sample predictive power was found for all the regional indices, 15 of the developed countries, and 6 of the emerging nations.

Amir Alizadeh and Gulnur Muradoglu used the BDI to implement simple trading strategies (“Stock Market Returns and Shipping Freight Market Information: Yet Another Puzzle!”). The strategy was very simple. For the long/short strategy, each month they went long or short depending on whether the BDI went up or down in the last month. The long only version would be either long or in T-Bills. Returns and Sharpe ratios for the major indices between 2000 and 2010 are shown in the table below (from their paper).

All the usual caveats about academic studies apply here. Specifically, costs aren’t included, the Sharpe ratio is calculated assuming a rate of zero and the indices can’t be directly traded. Nonetheless, the results are encouraging, and the general idea holds up: the BDI is predictive.

Disclaimer

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