Empirial Observations On The Predictive Power Of A Divergent Baltic Dry Index

Yesterday's drop of the BDIY to a one year low, coupled with stocks' (brief) jump to a one year high had quite a few technicians on edge: it isn't  every day that we get such a major divergence between the two data series. But does this actually mean anything, and does it predict much in terms of future market performance? For the answer we go to one of the best technical analysts out there, Sentiment Trader, who shares the following piece of advice to those who are curious how stocks have traded in past occurrences of such notable divergences: "Overall, the S&P's median return over the next month or so was certainly below average, and I would consider this to be a minor negative, but not a major or terribly consistent sell signal." That said, there is also the threat that China is merely continuing to add additional supply in terms of Cape and other sized tankers, and we are confident that to some the plunge in shipping rates will be actually seen as a positive as it means less money has to be spent on chartering trans-Pacific transport. Which is good - a difference in opinions is, after all, what makes market.

From Sentiment Trader:

The Baltic Dry Index (BDI), a common measure of global shipping rates, is one of those fascinating indicators that both bulls and bears love to trot out when it suits their purposes.  When it doesn't, they don't.
 
We've touched on the indicator a couple of times over the past few years, as it has been only mildly predictive for stocks going forward.
 
Since it's getting some attention once again, though, let's revisit it.  It's notable now because the BDI has hit a one-year low at the same time the S&P 500 closed at a one-year high (OK, I'm fudging a tiny bit here due to Tuesday's slight dip).  That is quite unusual.
 
Going back to 1985, the furthest back I have daily data, there have been 50 other days with a similar divergence between stocks and the BDI.
 
A little more than a month after those occurrences, the S&P was positive 18 times (a 36% success rate) and had a median return of -0.8%.  Its median maximum decline during those month-long periods was -2.6% and median max gain was +2.2%.
 
It proved to be an excellent heads-up to future market weakness in June 1986, May 1990, January 1994, June 1998 and July 2005.  But it failed to lead to any meaningful downside in October 1995, January 1996, September 1996 and January 1998.

Overall, the S&P's median return over the next month or so was certainly below average, and I would consider this to be a minor negative, but not a major or terribly consistent sell signal.