Exchanges Are A Buy As Trade War Tensions Heighten

 | May 09, 2019 05:34AM ET

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 (NASDAQ:CME)

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.

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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.