Trade Tensions Resume
Trade war tensions are growing between the world’s two largest economies, as both China and the US take more aggressive stances. We as investors, need to start looking at how to reallocate our portfolio in the case of this trade war further escalating. If these trade discussions were to turn south, the broader equity market would likely sell-off, and investors will flock to safe-havens such as low beta stocks, gold, and fixed income investments.
Washington made steps Wednesday to push $200 billion of China’s imported goods to a 25% tariff from their current 10% rate. Trump was retaliating to China’s comments on Sunday about having no intentions of detailing some of their existing trade laws, something that Trump was sure they had agreed to.
China is taking a more aggressive position in this trade war due to a bounce back in the Chinese economy, reporting 6.6% GDP growth from one year prior. Trump’s criticism of the Federal Reserve raising interest rate too quickly is leading Chinese officials to believe that our economy is fragile. They are aware that Trump views the Dow Jones Index as his report card and he will do almost anything to protect its performance. Chinese officials are attempting to take leverage this in trade negotiations as their economy stabilizes.
The equity markets haven’t priced in any additional tariffs on Chinese imports which will have a negative effect on prices. A trade agreement between the US and China has been mostly priced in so any further flames to the fire will weigh heavily on the markets. I see only neutral to downside potential with these ongoing trade negotiations with China.
Low Beta Exchange Stocks:
Chicago Mercantile Exchange (CME - Free Report)
CME has a beta very close to zero, just today as the markets sold off, the CME group rallied. CME is an exchange in downtown Chicago that offers firms a wide variety of different derivatives and futures to hedge their business. The exchange is also used by speculative day traders who believe they can beat the market. As a prior trader on the CME Globex, I can assure you that this is no easy task especially when your volume is low.
When the market breaks down companies tend to hedge more of their business due to the perceived risk associated with a market downturn. Traders on the CME exchange are also trading larger volumes because of the increased volatility. The more volatility the more opportunities to profit.
The CME Group's revenue is driven almost entirely by volume and as the markets break down the volumes increase for the reasons mentioned above.
Most of the volume that is traded on the CME is from interest rate derivatives, which are used to help businesses hedge floating interest rates, expected future borrowing as well as expected future lending. They also offer futures and options in equities, foreign exchange, agriculture, and commodities.
Volume has consistently increased over the past 5 years for the CME group by an average annual rate of 9%. This growth has been primarily driven by CME Globex, their online platform that makes it easier for any business to hedge, no matter the size. The past 5 years have been relatively low volatility, so when the markets hit the fan expect CME to reap the benefits
Below you can see a comparison of the S&P 500 (red) and CME (blue) over the past 52-weeks.
Intercontinental Exchange (ICE - Free Report)
The ICE exchange is one of the largest exchange owners in the world, operating 12 regulated exchanges including the New York Stock Exchange, the largest equity exchange by volume. ICE also owns many derivative, futures and options exchanges similar to how the CME operates.
NYSE makes up the most substantial portion of ICE’s top-line. When the equity market sells-off the initial volume from the break-down is going to boost revenues for ICE but once everyone is out, investors are typically hesitant to get back in before they see an upward trend. This leads to periods of low volume after significant bearish moves in the market. A market downturn would be a double-edged sword for ICE; luckily they have 11 other exchanges to hedge some of the negative volume effects in NYSE.
ICE has a beta closer to 0.5, meaning that it only marginal follows the broader market trends. The stock is currently trading at a discount to the securities exchange industry with a 20.73x P/E compared to the average exchange trading at 23.68x. ICE is also trading far below the PEG of the sector at 2.49x compared to the average exchange which has a PEG of 3.13x. This firm has seen both consistent top and bottom line growth.
ICE is trading at a better price than CME but it follows the markets more closely, lowering its ability to hedge your portfolio.
Cboe Global Markets (CBOE - Free Report)
Cboe is rallying 1.5% today as the rest of the equity markets sell-off. Cboe is best known for its volatility index, the , which a lot of investors refer to as the “fear index”. This is used to measure the amount of volatility (to the downside) in the market at any point. Traders and institutional investors use this to hedge their portfolios in the case of a downturn. This past week the broader equity market is down close to 2.5% and the VIX spiked almost 50% in the same time frame, caused by the fears associated with the ongoing trade dispute.
Cboe also offers similar options and futures that the previous two exchanges provided. Its beta is around 0.2 meaning that it is correlated with the market only marginally. Cboe is trading at a 21.7x forward P/E, below the industry average. This firm has shown inconsistent volume growth which makes me hesitant to call this a strong investment option. Analysts have lowered their EPS estimates for Cboe over the past 90 days which has moved this stock to a Zacks Ranking #4 (Sell).
Keep an eye on the trade negotiations over the next few weeks to assess it's progession. These negotiations, that have resumed today, have a substantial downside potential for the markets considering an agreement has been partially-to-completely priced into the markets. These security exchange stocks, that I discussed above, would make an excellent hedge for your portfolio and have solid upside potential no matter what the trade war outcome.
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