The Merc: A Bet on Futures

09/03/2004 12:00 am EST

Focus:

Mark Skousen

Editor, Forecasts & Strategies, High-Income Alert

You may not be comfortable trading in futures or commodities. But two top advisorsMark Skousen and Alexander Greenlook at a company that benefits from increased activity in these marketsthe publicly traded shares of the Chicago Mercantile Exchange.

"We would also like to recommend a new stock that will knock your socks off Chicago Mercantile Exchange (CME NYSE)," says Mark Skousen, editor of Forecasts & Strategies . "The Merc is the world’s largest futures exchange. It’s only been public for less than two years, but has already seen an explosion in its revenues and earnings, primarily from the transaction fee it earns each time a futures contract is bought or sold. Most recently quarterly earnings rose 32% and earnings soared 76%, and it's still selling for only 28 times earnings. Since CME earns money on increasing volume, whether the markets are going up or down, this is a great choice for us right now. It’s beating the indexes and will continue to do so. It's currently off its all-time high, and might be splitting soon, so it's a good time to load up. I see it moving higher in the near future."

"The Chicago Mercantile Exchange is in the uncertainty business," says Alexander Green, investment director for The Oxford Club. "It operates as a financial intermediary between people who want to buy freedom from uncertainty (producers and hedgers) and those who want to profit from it (speculators). For example, if you're a pig farmer and want a guaranteed price for your livestock when you take it to market, you enter into a futures contract, which guarantees what you'll be paid upon delivery of your pork bellies. A speculator, on the other hand, may have good reason to believe prices for those pork bellies are headed higher. If he's right, the value of his futures will rise. If not, he'll take it on the chin. But as Merc shareholders, we don't care which way prices go. We're simply making money off their bets.

"The Merc is in a growth business because financial uncertainty never ends. Institutions, for instance, use futures to control their stock market risk. And the Merc controls 95% of the market for stock-index products in the US. Multi-national corporations want to hedge their currency exposure. And they do it on the Merc. In a recent week, for example, the Merc traded 1.82 million Eurodollar contracts in a single day, an all-time record. Buyers and sellers want to reduce the uncertainty in the price of raw materials. And the Chicago Mercantile Exchange is where they meet.

"The Merc started the year trading 2.54 million contracts a day, on average. But that number is steadily rising. In July, CME traded 3.2 million contracts a day, a 13.6% increase over the same month a year ago. To put all this swapping in perspective, last year the Merc traded 640 million contracts with an underlying value of $334 trillion. For comparison purposes, the total GDP in the US is approximately $10 trillion. The Merc does more volume in the first two weeks of the year than the New York Stock Exchange does all year. And profit margins tend to be high across the board, because the exchange's trading technology is already in place. It won't cost any more to trade five million contracts a day than four million. Needless to say, earnings growth is substantial. Recently released second-quarter earnings jumped 61%, beating analysts' estimates handily. Unless the world suddenly becomes a dramatically safer place, you can expect this stock's strong trend to continue."

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