Shippers Set to Play Catch Up?

It's helpful to observe the relationship of assets classes to one another; sometimes seemingly disparate indices provide insightful studies for investors seeking the new emerging trends and outperformance. It might seem silly to compare the "performance" of the Baltic Dry Index to the S & P 500 (silly because one can't invest directly in the BDI via the equity market), but the relationship between the performances of the two can result in an actionable investment theme.

As a backdrop, currently the fundamentals of shipping are giving mixed signals. Optimism is coming out of China, where the bet is that the Mainland can singlehandedly pull the global economy up by its bootstraps. In actuality, the tea leaves are difficult to read right at this moment. While stimulus of almost $1 trillion (USD) will be added to the economy by the Bank of China, the debate goes on to question will it be wisely spent, just as the debate goes on here in the US. And as we all know, China will need to transition from its over-reliance on exports to a more balanced, domestic consumption-driven economy.

Meanwhile, there remain questions as to whether the latest uptick represents a sustainable demand trend. Purchasing managers may simply be restocking or, worse, are even stockpiling in order to strengthen their bargaining positions in the looming, contentious negotiations with the big iron ore producers. China desires increasingly secure access to the raw materials required to modernize, and she is looking at the global downturn as an opportunity to buy cheap foreign assets and gain favorable supply contracts. Thus, a drawn out standstill is playing out now, causing great uncertainly in gauging real demand, particularly in the Capesize ships.

Historically, shipping has been prone to boom and bust cycles. Potentially, the supply of

new ships scheduled to be delivered could increase the fleet significantly in the next 3 years. However, the scrapping of old vessels and newbuild cancelations are already working to mitigate oversupply concerns in many classes.

Long-term challenges should not lie with the demand to ship goods per se but with the shippers and how many vessels they have exuberantly ordered for delivery.  Can they scrap and cancel orders at a rate that will help balance rates? That the current difficult conditions will lead further liquidation of vessels and even certain companies is not hard to predict, but global trade will go on and the well positioned shippers will be there to benefit over time.

So how is all this showing up in the price action of the sector?

Weeks ago, I wrote on the resurgent BDI and its likely outperformance surrounding the relative strength buy signal it gave. Why does this standout in my database? Relative strength is something I pay attention to; in my opinion it is one of the most useful tools in chart-based analysis, and I happen to track this metric on a point and figure basis. Buy or sell signals are long term in nature and tend to stay in place for an average of 2 years, often leading to wide outperformance. The BDI has become a mainstream indicator, widely followed, much derided, not completely understood.  But when you get the direction heading in your favor, a confirming signal is worth acting upon.

First let's look at the relative strength chart, shown here with the signal history of the BDI vs. the S&P 500:

 

 

And that relative strength buy signal vs. the S&P 500 on 2/2/2009 led to the first upside breakout on the absolute BDI price chart in March:

 

 

What's the performance been of the most recent history of the relative strength signals over the last few years? Take a look at the chart below

 

 

What does this mean for investors looking to play the global rebound via shipping holdings? I feel most confident in the direction and the magnitude of a trend when I see a confluence of pricing in the BDI, the Forward Freight Agreements (FFA's, essentially the shipping futures market) and the equity universe. Currently you have only the BDI exhibiting consistent strength while the FFA's have faded and shipping equities remain near their lows.

Year-to-date performance suggests shipping equities are further behind in their bottoming process than the Baltic Dry Index. Credit concerns and counter party risk still weigh heavily on these stocks. And whilethis sector remains the canary in the coal mine proxy for global trade and might normally turn up ahead of the broader market, investors have lost such faith in the economy that the shipping equities to lag this time around.

While individual shipping stocks or the Claymore/Delta Global Shipping ETF (NYSE: SEA) have underperformed since the relative strength buy signal on the BDI in February, it's still early on that signal. Remember, relative strength signals are typically in place for 2 years and they have been excellent recent indicators of looming outperformance. If this market rally does end up having some staying power, shippers could play catch-up in a big hurry.

**Disclaimer: the author's firm serves as portfolio consultant on a Shipping sector UIT, and it provides the index which underlies the Claymore/Delta Global Shipping ETF (NYSE: SEA).