EIA oil import data

EIA oil import data are at the lowest levels since 1986. If you take out Canada, oil imports are at the lowest levels ever recorded by the EIA. The oil boom is a huge impact on the US economy, the dollar and the global oil market. It is the new peace dividend.  Without an oil problem, a number of geopolitical issues decline in importance. US growth is being driven by the oil boom. Capital expenditures and employment in energy is rising and the cost to run factories is very manageable relative to other parts of the OECD. The chemical industry is being significantly helped. The current account deficit is more manageable when oil imports are controlled. There is even more talk from the rest of the world that the US should "share" its new found supplies. Lifting the ban on oil exports is a real discussion point.  All the impact is right there in the EIA data.

Russia, geopolitics, and gas

Very broadly speaking, Europe's dependency upon Russian gas imports increases proportionately with proximity to its borders. So we have the Baltic States, which import 100% of their gas from Russia, Greece imports 56%, Germany 37% and the Netherlands 5%. The largest importers in aggregate terms are Germany and Italy, which constitute almost half of the EU's total demand (though the likes of France, Hungary, Czech Republic, Poland, Austria and Slovakia are all big importers, receiving over 5 billion cubic meter per year.) However, whilst Germany uses gas for just 20% of its overall energy needs, Italy uses gas to fuel almost half its power plants and is currently securing winter rates of more than EUR 2 per megawatt hour above those in northwest Europe. Italy suffered serious disruption during the previous Russian-Ukraine disputes back in 2006 and 2009 and it may yet have to look to pricey Algerian supply if the current dispute continues.

From BNY Mellon morning briefing

This is an interesting take on the geopolitical issues associated Russia and Ukraine. The gas issue is very relevant. Sanctions have been imposed but there is limit to how much risk the EU wants to impose on its economies through the cost or disruption of energy. Geopolitics often play out in commodity markets.If it were not for commodity markets, many political issues would be ignored.

Credit spreads and equity markets

Cross market information provides useful information on how markets may behave. The credit spread or risk premium above Treasuries tells us something about the supply and demand for credit sensitive investments as well as the default risk of levered companies. A simple analysis by the Market Compass blog proves the point. When spreads widen by even 25 bps in a 60 day period, the S&P 500 will generate negative returns. Similarly, if there is a tightening of credit spreads, the S&P 500 will have strong positive returns. This tendency is especially strong if the S&P500 index is already trending lower.

The price of credit tells us something about market returns. It makes good intuitive sense that if credit becomes riskier, there will be a fall-out with the residual value of the firm. My guess is that this will be even stronger for small cap firms or those that are highly levered.

Momentum versus 60/40 mix

We were asked to provide some simple model evidence on the quality of momentum and versus a simple balanced portfolio. We provide a simple case using only two assets. We use the 60/40 stock /bond combination as a benchmark. 

Use momentum indicator based on rolling six month returns. Allocation map will avoid negative momentum assets and hold positive momentum assets. If both assets (SPX and TLT) are positive, we hold the 60/40 mix. If both are negative, we hold half the normal allocation. If the stocks outperform bonds, we hold more stocks and if bonds outperform stocks, we hold more bonds. The minimum allocation for stocks is 30% and the minimum allocation for bonds is 20%. There is not a lot of variation from the benchmark. There is no shorting. There is no use of leverage. 

The gain in return is significant. If there is positive momentum, holding cash makes sense. If there is a bias in performance of one asset over another, favor the better performing asset. There is still diversification, but just some simple tilts. This simple model works with only one down year in ten.