Stock exchanges are beating other stocks

A pickup in volumes on higher volatility in 2018 has been a boon to exchanges and market makers.

  • By Steven Russolillo,
  • The Wall Street Journal
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In a year of battered global markets, one group is proving to be a big winner: stock exchanges and trading firms.

U.S. exchange operators such as New York Stock Exchange parent Intercontinental Exchange Inc. (ICE), Nasdaq Inc. (NDAQ), and CME Group Inc. (CME) are up by double-digit percentages this year. Internationally, the same goes for Germany’s Deutsche Boerse AG (DBOEY) and Australia’s ASX Ltd. (ASXFY).

The biggest gainer: Virtu Financial Inc. (VIRT), a high-speed trading firm in the U.S. that thrives on market volatility. Shares of Virtu, whose primary business is market-making, have soared 38% this year.

Even in a beaten-down market such as Hong Kong, the city’s exchange operator— Hong Kong Exchanges & Clearing Ltd. (HKXCY) —has fallen by only about half as much as the benchmark index.

“Exchanges are sitting in a very pretty place in a lot of ways,” said Brad Bailey, research director for capital markets at Celent in New York.

Analysts and investors attribute this performance to large swings in stock, bond and currency markets. After historically calm trading conditions last year, a pickup in volumes on higher volatility in 2018 has been a boon to exchanges and market makers—intermediaries who stand ready to buy or sell shares at any time.

“When volatility hits, volumes will be there,” Scott Hill, chief financial officer at ICE, said on an earnings call in October.

While many assets have fallen victim to slowing global growth, tighter monetary policy and rising trade tensions, exchanges and trading firms tend to benefit from the trading activity bred by rising uncertainty. Plus, a surge in initial public offerings has helped fuel these companies’ top and bottom lines.

“These businesses live off of trading and IPOs,” said Olivier d’Assier, head of applied research for the Asia-Pacific region at Axioma, which sells financial analytical tools to asset managers. “We’ve seen a lot of that.”

More than $50 billion was raised through new listings in the U.S. through the first three quarters of the year, which put 2018 on track to be the busiest year since 2014, according to Dealogic.

Mr. d’Assier said heightened geopolitical risk, particularly as it relates to U.S.-China trade tensions, and the market reactions that follow, also benefit exchanges. “This kind of environment creates marketwide moves rather than sector-specific ones,” he said. “And volumes are usually much bigger when that happens.”

The global value of shares traded through electronic order books has risen to $81.4 trillion this year through October, up 20% from a year ago, according to data from the World Federation of Exchanges.

Investors tend to like the exchange model because it makes the companies more profitable when trading volume picks up without exposing them to large risks associated with the direction of prices.

A transaction-based business model in a time of heightened volatility is beneficial, said Larry Tabb, founder of research provider Tabb Group. For instance, a big source of ICE’s revenue is transaction and clearing fees.

Also, many of these companies have diversified in recent years by emphasizing their data businesses, Mr. Tabb said. In addition to real-time stock prices, exchanges sell more-expensive data feeds—mostly to banks and high-frequency traders—that reveal buy and sell orders posted by traders.

Exchanges and market makers have done better than brokerage firms and investment banks in part because they are agnostic on the market. The S&P 500 financials sector is down 3.7% so far this year through Friday.

“If you’re an investment bank, you’re taking a position and holding a view,” Mr. d’Assier said. “Market makers don’t have views. They just look at the volatility and think how expensive is it going to be for me to get out of this position and still make a profit.”

Turbulent markets have helped Virtu, a market maker that continuously quotes stock values. The firm profits from the difference between the buying and selling prices of stocks. As volatility picks up, these spreads widen, thereby boosting the firm’s margins. In early November, Virtu said it was buying brokerage Investment Technology Group Inc. (ITG) in a nearly $1 billion deal.

One exchange that hasn’t done as well this year: Cboe Global Markets Inc.(CBOE) The company has been dogged in recent months by concerns about volatility trading. Allegations of possible manipulation of the VIX index (.VIX), Wall Street’s so-called fear gauge and perhaps Cboe’s best-known product, have tempered some enthusiasm for products linked to the VIX. Cboe’s shares are down 14% this year.

Cboe said it couldn't comment on ongoing litigation. It said while demand for VIX-linked products often fluctuates alongside market volatility, dips could be offset by higher demand for index options, another instrument it specializes in.

Analysts predict revenue and earnings will continue to grow next year at ICE, Nasdaq and CME but at a slower pace than in 2018, according to estimates compiled by FactSet.

Still, just because trading volumes are up doesn’t necessarily mean they will stay that way in the future, Mr. d’Assier said. “Volume is a lagging indicator,” he said. “It doesn’t tell me anything about what’s going to happen in the future.”

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