Unemployment, the Baltic dry index and bull markets

At least that is what everyone is saying. We are even seeing growth forecasts for the final quarter of 2009 and the first half of 2010.

But what about February-March of this year...?

"When those same people reported that the economy was in "the worst recession since the Great Depression."

That was the exact point when stocks and commodities started to rally.

So what's changed?

First of, at major market bottoms and tops you will see fundamental news means almost nothing. Remember back in 2007 at the market top when news flow was overly positive and investors were excessively optimistic. We all know what happened after that... Then recently in March when investors where overly pessimistic and the news flow was oozing negativity. You can't forget the +50% rally we have just had (having). Neither matches the fundamental news at the time.

The question is now do the fundamentals support the recovery?

A quick look at the US Unemployment (below) figure would suggest we are not in for a quick recovery. Although unemployment is a lagging indicator it is clearly skyward bound compared 2007. Since the US recession began in Dec 2007 they have shed 6.9M jobs and forecasting it to peak at around 10.5% (currently 9.7%).

Source: Bloomberg

With so many people out of work can the recovery really be that fast?

If we look at the Baltic Dry Index (below), which is a gauge of what it costs to ship raw materials to an end user, it is starting to drift back. The BDI is seen as a leading indicator of economic activity as without raw materials there is no or low production.

Source: Bloomberg

We are definitely not on our lows like November 2007 but we are certainly having a pull back of the recent highs.
What drives the Baltic Dry Index up or down?

Baltic Dry Index (BDI) is probably one of the purest leading indicators of real time economic activity - particularly in the area of global raw material and infrastructure demand.

The BDI is only open to members who actually participate in the contracts or those who have actual cargo to transport. Therefore external forces like hedge funds, political agendas and speculators cannot manipulate the underlying value of the index.

The BDI is used by external parties to see what countries are prepared to pay to import raw materials right now for production. Commodities include, metals, grains and crude oil.

To give you an idea of how severe the move from the highs to the low was, at the high point the price of chartering a entire bulk freighter was ~$300,000 USD and at the lows was ~$10,000 USD. That is a big swing in the supply/demand curve.

Price Increases get passed straight to Businesses and Consumers.

As the BDI increases, so to does the cost of transporting raw materials. The costs associated with obtaining raw materials needs to be passed on to each user up the food chain. As such we see price increase as each user adds their profit margin. The net result is the consumer ends up seeing a higher price for their products.

The Baltic Dry Index is worth keeping an eye on to see changes in supply and demand.

As we all know markets don't move up in a straight line forever but what we do know is while they are trending up we need to stick with them.

The trend is your friend until it bends...