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Bear of the Day: CME Group (CME)

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Traders of financial instruments tend to find periods of volatility to be the most profitable. The increased volumes, uncertainty of prices and wide bid-ask spreads tend to create opportunity for professional trading firms.

They’re not the only ones who profit from volatility, however. With $5 billion in annual revenues, CME Group (CME - Free Report) is the world’s largest  What began as the tiny “Chicago Butter and Egg Board” for trading agricultural commodities in Chicago grew into the Chicago Mercantile Exchange, which demutualized and sold shares in 2002 and then went on an acquisition spree, buying its crosstown rival the Chicago Board of Trade as well as New York commodity exchanges NYMEX and COMEX.

The CME pioneered trading in financial derivatives – futures and options on currencies, interest rates and stock indices rather than just physical commodities. As the clearing house for trading in such a wide variety of instruments, the CME also developed a software algorithm for determining the risk being taken by each market participant and mandating performance bond requirements that eliminate counter-party risk.

“SPAN” margin software – a commercially available suite employing the CME’s risk control logic - is used by over 50 exchanges, clearing agents and regulatory agencies around the world.

As an investment, CME shares can act as essentially a hedge against market volatility. When stocks and interest rates are moving significantly every day, traders around the world have an immediate and pressing need for the instruments available on the exchange and CME acts as a gatekeeper, collecting a tiny toll on millions and millions of transactions every day.

At the beginning of the Covid-19 epidemic, many industry observers expected CME Group to perform especially well as traders and investors used derivatives to hedge exposure as well as speculate on the prices of equities and interest rates.

The chaos was short-lived.

An exchange thrives on uncertainty and the actions of the US Federal Reserve have – quite intentionally – reduced that uncertainty with the intent of stabilizing markets and reassuring participants.

Unfortunately for the CME, when the Fed is largely in control of interest rates, there’s not much need for trading in derivative securities based on short term rates or longer term government debt securities.

Similarly, as stocks have staged a steady rally off the March lows, recently  making several new all-time highs, traders have less use for derivatives on the S&P 500 and NASDAQ 100 indices. 
Agriculture prices have been similarly steady for unrelated reasons. The same goes for oil. One bright spot is precious metals, but there’s not enough volume in those products to make up the shortfall.

The result is forecasts for revenues and earnings that are relatively flat in 2020 as well as in 2021.

The Zacks Consensus Estimate for 2020 revenues is $5.05B and for 2021 it’s $5.03B. It’s much the same story on the bottom line. Earnings estimates have been revised down to a consensus of $7.07/share, earning CME Group a Zacks Rank #5 (Strong Sell). For 2021, the consensus earnings estimate grow only three cents to $7.10/share.

CME Group is a solid company with over 100 years of tradition, but in the present situation – and compared to stocks that have been on a real tear lately – CME Group looks stuck in the mud.

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