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New Sector Futures Give Traders More Hedging Power

Semiconductors and biotech are among six new sector index futures CME Group launched recently. Traders weigh in on the advantages of futures for these…

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Semiconductors and biotech are among six new sector index futures CME Group launched recently. Traders weigh in on the advantages of futures for these and other increasingly active sectors.

Energy sector volatility and surging oil prices have sharply boosted interest in energy trading this year. Likewise, global semiconductor shortages have made that sector a top headline in recent months, fueling interest from traders looking to cut risk or gain from unprecedented volatility. Meanwhile, biotech stocks are seesawing amid lingering pandemic fears or volatility that can come from a new blockbuster drug, making them a favorite of 2022 screens.

Until now, most of these highly watched sectors were not available to trade as futures contracts. To bridge this gap, CME Group launched six new E-mini sector index futures in August, giving traders greater flexibility to hedge positions on increasingly popular economic sectors amid historic stock market volatility. Along with oil and gas exploration and production, and semiconductors and biotech, customers can also trade contracts on indices tracking the performance of regional banks, insurance, and retail. The new offerings “hit home where there is greatest volatility,” according to Anthony Crudele, a futures trader and host of the Futures Radio podcast.

Robust Demand and Early Adoption

Underscoring brisk demand for such products, screens have been strong so far. More than 11,000 contracts changed hands in the first full month of the new sector futures launch, up sharply from the 48 that were initially traded when CME Group introduced sector futures in 2011. In the first half of 2022, sector futures' average daily volume is up 10% to over 19,000 contracts while on a three-year basis, it has climbed roughly 50%. The six new products bring CME Group’s total offering to 19 equity sector index contracts.

Read more about equity index sector futures

The decision to roll out the new contracts stemmed from robust client interest. "We continue to see strong market demand for liquid, cost-effective, and capital-efficient tools to track the same underlying indices as some of the most popular ETFs," said Tim McCourt, CME Group global head of Equity and FX Products. 

Graphic: CME Group Sector Index Products Volume and Open Interest

Paul Woolman, head of EMEA Equity and Alternative Index Products at CME Group, highlighted semiconductors as an example. 

“Semiconductors is an active space and something which we didn’t provide exposure to before, so we started to see client requests for additional sector futures products,” he said. 

Market participants have also been seeking greater granularity in the financials space, where the broader “financials” sector offerings may not be specific enough to address their risk management needs. The new regional banks and insurance sector futures help address this need for greater precision, added Woolman. 

The new sectors are also eligible for derived block functionality, which provides market participants with greater choice in the way they can seek liquidity by sourcing it from related markets such as ETFs or underlying stock baskets and then transferring it into the sector futures product.

Sector Rotation Drives Alpha

Clients can also obtain relative value, or alpha, by rotating between outperforming and underperforming sectors underlying a broad index, according to Woolman. They can pit sectors against each other, an index or a single stock, and take a directional view if they think, for instance, that a specific segment will perform in a certain way. 

Jon Corin, vice president of delta one trading at Citi, said the new sector futures fit within “a full universe of financing products that allow us to switch between swaps, futures, cash and ETF funding. Now we have the ability to look at relative value between these different instruments and an opportunity to fund our book in more creative ways.”

Derived Block Trades and Capital Efficiency

Derived Blocked trades are also gaining traction with the institution’s customers. “We have had a number of clients checking prices and getting familiar with the tool so there is growing appetite for its use,” said Steve Christian, managing director of execution sales at Citi. “The facility allows clients to access underlying liquidity at any point during the cash session. That is an improvement from the previous, more captive basis trade at index close (BTIC) which was settled at the end of day.” 

The last (or Phase 6) of the Uncleared Margin Rules (UMR) regulation raising buy-side firms’ margin costs came into play on September 1, putting 1,100 firms into scope. As firms work to adapt to new initial margin requirements, managing capital efficiency has become increasingly crucial. 

The fledgling sectors help in this regard, especially when it comes to trading futures versus ETFs, according to Joe Paccione, head of Americas Futures and Options Sales and Execution at J.P. Morgan.“ 

With UMR continuing to phase in, capital efficiency is on everyone’s mind,” he said. “As more and more of the OTC products move to listed, it creates additional resources to balance exposure and enhance margin efficiencies.” 

Amid this shake-up, the ability to execute block trades has become a "turning point,” he said. "The derived blocks create additional access to liquidity throughout the day, allowing traders an alternative method of getting their hedge off, potentially putting that risk into futures,” he said. "I think that feature brings it on par with other products. Then you add in capital efficiency and the UMR rollout, I can see more and more interest moving to futures.”

Sectors to Watch: Oil, Semiconductors, Biotech

Meanwhile, Crudele expects the increasingly popular oil and gas and semiconductor and biotech sectors to gain the most traction as traders begin using the new contracts. 

“The oil and energy sectors are the most popular in the S&P 500 this year so there is a lot of liquidity,” he said. 

“Semiconductors and biotechs are also high-flying sectors right now,” Crudele added. “With semis, you have a massive amount of volatility coming as you never know what will happen with geopolitical risk, and semis are a key part of our technology world. When you look at Nvidia and AMD, for example, a ton of retail and professional investors are trading these stocks every day.” 

The biotech industry also remains susceptible to headline-driven volatility. “We are in a world where a lot of headline risk is going to come from the biotech side of things because of fear of new COVID-19 variants or a new pandemic and now the Monkeypox outbreak,” added Crudele. Paccione at J.P. Morgan says the firm’s clients have more options as attention moves from one sector to another. “It’s not that one is more popular than the other or one is more desirable than another,” he says. “Now that you have this option within the futures' construct, it will provide an additional alternative for customers, allowing them to use futures as opposed to just the OTC markets or ETFs.”

Greater Precision

Crudele also sees traders using block trades to more precisely manage risk or express their view on a particular sector or index performance. 

“The exciting part of the E-mini S&P is that it’s the most widely traded index in the world. From that perspective, we can now trade the strongest versus the weakest sectors and create strategies beyond trading the single index,” he mused. Before the six new sectors’ launch, “we mostly traded S&P and ESG indices, but these new sectors are really hitting where the volatility is in the current marketplace,” he added.

“If you have a big stock portfolio and you look at the S&P and say, ‘I want to short it but have a heavy weighting in oil and semiconductors,’ you can offset that by going short on the S&P and simultaneously long on oil and semiconductors. In this way, you can more accurately express your view."

”Citi’s Corin expects demand for the E-mini sector futures to grow sharply in the future. There are many investors who don’t have the ability to trade cash instruments so this could open up a window for certain market participants to trade sectors they have not had access to historically, generating additional liquidity in the process.”

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Stay Ahead of GDP: 3 Charts to Become a Smarter Trader

When concerns of a recession are front and center, investors tend to pay more attention to the Gross Domestic Product (GDP) report. The Q4 2022 GDP report…

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When concerns of a recession are front and center, investors tend to pay more attention to the Gross Domestic Product (GDP) report. The Q4 2022 GDP report showed the U.S. economy grew by 2.9% in the quarter, and Wall Street wasn't disappointed. The day the report was released, the market closed higher, with the Dow Jones Industrial Average ($DJIA) up 0.61%, the S&P 500 index ($SPX) up 1.1%, and the Nasdaq Composite ($COMPQ) up 1.76%. Consumer Discretionary, Technology, and Energy were the top-performing S&P sectors.

Add to the GDP report strong earnings from Tesla, Inc. (TSLA) and a mega announcement from Chevron Corp. (CVX)—raising dividends and a $75 billion buyback round—and you get a strong day in the stock markets.

Why is the GDP Report Important?

If a country's GDP is growing faster than expected, it could be a positive indication of economic strength. It means that consumer spending, business investment, and exports, among other factors, are going strong. But the GDP is just one indicator, and one indicator doesn't necessarily tell the whole story. It's a good idea to look at other indicators, such as the unemployment rate, inflation, and consumer sentiment, before making a conclusion.

Inflation appears to be cooling, but the labor market continues to be strong. The Fed has stated in many of its previous meetings that it'll be closely watching the labor market. So that'll be a sticky point as we get close to the next Fed meeting. Consumer spending is also strong, according to the GDP report. But that could have been because of increased auto sales and spending on services such as health care, personal care, and utilities. Retail sales released earlier in January indicated that holiday sales were lower.

There's a chance we could see retail sales slowing in Q1 2023 as some households run out of savings that were accumulated during the pandemic. This is something to keep an eye on going forward, as a slowdown in retail sales could mean increases in inventories. And this is something that could decrease economic activity.

Overall, the recent GDP report indicates the U.S. economy is strong, although some economists feel we'll probably see some downside in 2023, though not a recession. But the one drawback of the GDP report is that it's lagging. It comes out after the fact. Wouldn't it be great if you had known this ahead of time so you could position your trades to take advantage of the rally? While there's no way to know with 100% accuracy, there are ways to identify probable events.

3 Ways To Stay Ahead of the Curve

Instead of waiting for three months to get next quarter's GDP report, you can gauge the potential strength or weakness of the overall U.S. economy. Steven Sears, in his book The Indomitable Investor, suggested looking at these charts:

  • Copper prices
  • High-yield corporate bonds
  • Small-cap stocks

Copper: An Economic Indicator

You may not hear much about copper, but it's used in the manufacture of several goods and in construction. Given that manufacturing and construction make up a big chunk of economic activity, the red metal is more important than you may have thought. If you look at the chart of copper futures ($COPPER) you'll see that, in October 2022, the price of copper was trading sideways, but, in November, its price rose and trended quite a bit higher. This would have been an indication of a strengthening economy.

CHART 1: COPPER CONTINUOUS FUTURES CONTRACTS. Copper prices have been rising since November 2022. Chart source: StockCharts.com. For illustrative purposes only.

High-Yield Bonds: Risk On Indicator

The higher the risk, the higher the yield. That's the premise behind high-yield bonds. In short, companies that are leveraged, smaller, or just starting to grow may not have the solid balance sheets that more established companies are likely to have. If the economy slows down, investors are likely to sell the high-yield bonds and pick up the safer U.S. Treasury bonds.

Why the flight to safety? It's because when the economy is sluggish, the companies that issue the high-yield bonds tend to find it difficult to service their debts. When the economy is expanding, the opposite happens—they tend to perform better.

The chart below of the Dow Jones Corporate Bond Index ($DJCB) shows that, since the end of October 2022, the index trended higher. Similar to copper prices, high-yield corporate bond activity was also indicating economic expansion. You'll see similar action in charts of high-yield bond exchange-traded funds (ETFs) such as iShares iBoxx $ High Yield Corporate Bond ETF (HYG) and SPDR Barclays High Yield Bond ETF (JNK).

CHART 2: HIGH-YIELD BONDS TRENDING HIGHER. The Dow Jones Corporate Bond Index ($DJCB) has been trending higher since end of October 2022.Chart source: StockCharts.com. For illustrative purposes only.

Small-Cap Stocks: They're Sensitive

Pull up a chart of the iShares Russell 2000 ETF (IWM) and you'll see similar price action (see chart 3). Since mid-October, small-cap stocks (the Russell 2000 index is made up of 2000 small companies) have been moving higher.

CHART 3: SMALL-CAP STOCKS TRENDING HIGHER. When the economy is expanding, small-cap stocks trend higher.Chart source: StockCharts.com. For illustrative purposes only.

Three's Company

If all three of these indicators are showing strength, you can expect the GDP number to be strong. There are times when the GDP number may not impact the markets, but, when inflation is a problem and the Fed is trying to curb it by raising interest rates, the GDP number tends to impact the markets.

This scenario is likely to play out in 2023, so it would be worth your while to set up a GDP Tracker ChartList. Want a live link to the charts used in this article? They're all right here.


Jayanthi Gopalakrishnan

Director, Site Content

StockCharts.com

 

Disclaimer: This blog is for educational purposes only and should not be construed as financial advice. The ideas and strategies should never be used without first assessing your own personal and financial situation, or without consulting a financial professional.

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Hotels: Occupancy Rate Down 6.2% Compared to Same Week in 2019

From CoStar: STR: MLK Day Leads to Slightly Lower US Weekly Hotel PerformanceWith the Martin Luther King Jr. holiday, U.S. hotel performance came in slightly lower than the previous week, according to STR‘s latest data through Jan. 21.Jan. 15-21, 2023 …

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With the Martin Luther King Jr. holiday, U.S. hotel performance came in slightly lower than the previous week, according to STR‘s latest data through Jan. 21.

Jan. 15-21, 2023 (percentage change from comparable week in 2019*):

Occupancy: 54.2% (-6.2%)
• Average daily rate (ADR): $140.16 (+11.3%)
• evenue per available room (RevPAR): $75.97 (+4.4%)

*Due to the pandemic impact, STR is measuring recovery against comparable time periods from 2019. Year-over-year comparisons will once again become standard after Q1.
emphasis added
The following graph shows the seasonal pattern for the hotel occupancy rate using the four-week average.

Click on graph for larger image.

The red line is for 2023, black is 2020, blue is the median, and dashed light blue is for 2022.  Dashed purple is 2019 (STR is comparing to a strong year for hotels).

The 4-week average of the occupancy rate is below the median rate for the previous 20 years (Blue), but this is the slow season - and some of the early year weakness might be related to the timing of the report.

Note: Y-axis doesn't start at zero to better show the seasonal change.

The 4-week average of the occupancy rate will increase seasonally over the next few months.

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American Express Numbers Show What Still Gets People to Spend Money

American Express stock jumped nearly 12% since earnings dropped.

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American Express stock jumped nearly 12% since earnings dropped.

Even though American Express  (AXP) - Get Free Report earnings announced Friday afternoon fell somewhat short of expectations for the quarter, shares still soared to highs unseen for many months due to a number of strong metrics -- quarterly revenue growth of 17%, plans to raise its dividend by 15% from 52 to 60 cents and an annual revenue that surpassed $50 billion for the first time ever.

At $52.9 billion, the latter is driven primarily by an increase in quarterly member spending. Last year, that number was at $42.4 billion. 

According to American Express Chairman and CEO Stephen J. Squeri, the increase can be attributed to higher numbers of millennials gaining in earning power and using their AmEx above other cards to tap into rewards as many approach milestones like marriage, career advancement, and homeownership.

"Millennial and Gen Z customers continue to be the largest drivers of our growth, representing over 60% of proprietary consumer card acquisitions in the quarter and for the full year," Squeri said in an earnings call discussing the results.

People Are Using Their AmEx Cards a Lot

The $52.9 billion number is up 25% from what was seen last quarter and reflects a number of different factors also having to do with post-pandemic spending.

"We ended 2022 with record revenues, which grew 25% from a year earlier, and earnings per share of $9.85, both well above the guidance that we provided when we introduced our long-term growth plan at the start of last year, despite a mixed economic environment," Squeri said.

AmEx further reported that 12.5 million new members signed up for cards in 2022 while existing members used their cards frequently. Fourth-quarter sales at AmEx's U.S. consumer services and commercial segments rose by a respective 23% and 15%.

But higher expenses also led to falling below analyst expectations. The fourth-quarter income of $1.57 billion, or $2.07 a share, is down from $1.72 billion ($2.18 a share) in the fourth quarter of 2021. FactSet analysts had predicted $2.23 a share.

"I'm not sure what that's really a function of right now -- whether it's a function of the economy or of confusion on where to advertise right now," Squeri told Yahoo Finance in reference to lower spending on the part of small business and digital advertisers. "We're going to watch that, but the consumer is really strong, travel bookings are up over 50% vs pre-pandemic."

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It's a Good Time to Be Tracking Credit Card Companies

Immediately after the earnings dropped, AmEx stock started soaring and was up nearly 12% at $175.24 on Friday afternoon. This is a high unseen in months -- the last peak occurred when, on September 12, shares were at $162.45. 

Whether due to or despite analyst threats of a looming recession, people have been using their credit cards very actively throughout the end of 2022.

When it posted its earnings earlier this week, Mastercard  (MA) - Get Free Report surpassed Wall Street expectations of $5.8 billion and $2.65 per share in fourth-quarter earnings. Visa  (V) - Get Free Report also saw revenue rise 11.8% to $7.94 billion in the same quarter. The numbers also reflect higher numbers of people traveling and using their credit cards in different countries.

"Visa's performance in the first quarter of 2023 reflects stable domestic volumes and transactions and a continued recovery of cross-border travel," outgoing CEO Al Kelly said of the results during a call with financial analysts.

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