It's "sink or swim" time for the shipping stocks.

 

The stock market is at a new 52-week high. But the shipping sector can't seem to get off the bottom. It's a strange development, given that many analysts claim the economy is bustling along. Worldwide shipments of coal, iron ore, and grains are at record-high levels. Yet the cost of shipping those goods is at a one-year low.

 

That's pressuring the share prices of the shippers.

 

Take a look at this chart of the Baltic Dry Index (BDI)...

 

 

The BDI displays the cost of shipping dry goods overseas. It's an excellent indicator of economic demand. After all, if the global economy is really picking up steam, the demand for dry goods and the cost of shipping them should be increasing.

 

But it's not. In fact, the BDI peaked last June at about the same time the Fed ended its original quantitative easing program. Then prices crashed.

 

Rumors of a second round of quantitative easing caused a bounce in the index in August. But those gains are gone now – even as the stock market continues to rally on the promise of an improving economy.

 

Something isn't right here. The stock market is either too far ahead of the economy, shipping prices are too far behind, or some combination of the two. To correct this situation, we'll need to see stock prices decline, shipping prices rise... or some combination of the two.

 

Stocks have avoided a correction so far. But it's just a matter of time before the bearish divergences take their toll. Many of the stocks with extended gains are going to get hit hard, and investors will be reminded that even the Fed can't guarantee forever-rising stock prices.

 

The stocks with the least risk at this point, however, are the shipping companies. The shipping sector hasn't participated in the stock market rally because the shipping stocks trade in relation to the Baltic Dry Index. With the index at its lows for the year, shipping stocks are near their lows as well... which makes the sector compelling from a valuation standpoint.

 

Indeed, it's hard to imagine stocks like Excel Maritime (EXM) or Diana Shipping (DSX), which trade at just two and eight times earnings, respectively, getting hit much harder.

 

Nonetheless, if the economic bulls are right, the BDI is destined to move higher and the shipping stocks have the most to gain. If the bears are right, the shipping stocks have already suffered and there won't be nearly as much downside as most of the other market sectors.

 

If you're looking for a low-risk, potentially high-reward trade to kick off 2011, you'll be hard pressed to find one better than the shipping sector.

 

Best regards and good trading,

 

Jeff Clark