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Exchanges M&A returns as holding companies diversify



For the exchanges that run the world’s biggest and most critical financial markets, it has sometimes seemed this year’s pandemic has had little effect.

In August, Intercontinental Exchange, the US trading, clearing and data provider, announced the $11bn purchase of mortgage software group Ellie Mae.

The deal was not only the largest in ICE’s 20-year history but also signalled that mergers and acquisitions, the industry’s biggest preoccupation of recent years, were back on the table. That was underlined in November when Deutsche Börse bought a majority stake in Institutional Investor Services for €1.9bn and Nasdaq paid $2.8bn for financial crime detection software maker Verafin.

The ICE deal was one Jeffrey Sprecher, its chief executive, had been working on in the background for more than a decade, he told a virtual conference for the futures industry in mid-November. He had long sought a business reliant on US interest rates, the benchmark for vast quantities of daily trading, and the deal slotted into the company’s long-term strategy of turning musty financial services into lucrative high-tech operations.

It would allow ICE to ride the transformation of the vast US mortgage market from cumbersome paper-based systems to digital ones. “It’s very much akin to what we do in futures trading in terms of the underlying technology,” he said.


deals in the industry in 2020, surpassing last year’s 19

That bullishness was born of a confidence that the pandemic that left many businesses in limbo had not extended to the industry that owns the main exchanges, clearing houses, benchmarks and data providers behind trading on markets. The industry sailed through the crisis. Exchanges stayed open and largely withstood the deluge of deals as markets convulsed in March and April. Margin calls to meet derivatives trades were met in all but a few cases. 

For many executives and regulators, this resilience justified the push after the 2008 financial crisis to hand exchanges more responsibility for market stability. Exchanges have expanded beyond their traditional role as the host for trading, looking to take a sliver of all aspects of a trade, from supplying data and analytics to managing the risk and settling it. Electronic trading has mushroomed, as have demands for data, boosting industry profits for the last decade. Competitors find it difficult to fully replicate the complicated network of buying and selling on an exchange.

The valuations of the biggest companies rebounded to, or even surpassed, pre-pandemic levels. Companies such as ICE, MarketAxess and S&P Global, the index provider, have more than doubled in the past decade, outstripping the S&P 500 financial index and well-known financial services stalwarts such as JPMorgan, BlackRock and Goldman Sachs.

The annual value of M&A deals in the industry is the second highest on record at $21bn so far this year, behind only 2019’s total of $28bn, according to data from FactSet. Last year’s number was swelled by London Stock Exchange Group’s planned $27bn deal to purchase data and trading group Refinitiv. The 30 deals this year have surpassed last year’s total of 24, said FactSet.


LSE Group’s planned purchase of Refinitiv

Even so, the pandemic may yet have a significant impact on executives’ thinking. Trading volumes have shrunk dramatically since the market panic around the coronavirus subsided. It has exposed the stark difference in business models between those that rely on activity from trading and more diversified rivals who have extensive revenues from indices and technology. 

The share prices of CME and Cboe, reliant on market volatility, have fallen by 13 per cent and 23 per cent respectively this year. In contrast the more diversified Nasdaq has risen 18 per cent and ICE has risen 12.3 per cent, in line with the benchmark S&P 500 index.

Central banks now have near-unlimited firepower to curtail sudden price movements and eruptions on markets, which has “significant potential ramifications”, says Nicholas Watts, an analyst at Redburn in London. The banks can suppress volatility and while there may be periods of high volatility, those periods will burst through longer stretches of lower-than-average volumes, he adds.

Law firm White & Case in August forecast that M&A levels in Europe would remain high as the largest businesses sought scale, volume and diversification. “Competition between market participants for the same high-value targets is likely to intensify,” it said. Most executives and advisers accept that buying national stock exchanges is politically fraught, even as the LSE aims to sell Borsa Italiana to Euronext for €4.3bn to satisfy European competition concerns over its Refinitiv deal.

Mr Watts forecasts a steady flow of deals, large and small, in tech and data, or less technologically-advanced areas of financial institutions such as back- and middle-offices, where deals are checked and settled. “Success in weathering a major real-world stress-test in the first half of 2020 will support [exchanges’] dealings with regulators and other capital market participants,” he says.

Big-ticket deals will further concentrate the business of running capital markets among a handful of actors. At the end of 2019 total global exchange revenues were $35.6bn, according to Burton Taylor International Consulting. 

The five largest exchange holding companies — ICE, CME, LSE, Deutsche Börse, Nasdaq — had strengthened their grip on the market, accounting for 53 per cent of the total and up from 50.8 per cent in 2015, the consultancy found.

For now many antitrust regulators around the world seem to be comfortable with the trend. US watchdogs approved the LSE’s purchase of Refinitiv by arguing that rivals and customers had significant bargaining power that would limit price rises or competition. 

But the biggest hurdle for completing the LSE deal will be securing approval from authorities in Brussels. Alongside the coronavirus, that ruling, due in mid-January, may set the tone for M&A for many years to come.

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Value investor John Rogers sees an end to Big Tech’s stock market dominance




The veteran value investor John Rogers predicted the US is headed for a repeat of the “roaring twenties” a century ago that will finally encourage investors to dump tech stocks in favour of companies more sensitive to the economy.

The founder of Ariel Investments told the Financial Times in an interview that value investing “dinosaurs” like him stood to win as higher economic growth and rising interest rates took the air out of some of the hottest stocks of recent years.

Rogers, who has spent a near four-decade career focused on buying under-appreciated stocks, said the frenzied buying of special purpose acquisition companies, or Spacs, signalled frothiness in parts of the market, even while a coming economic boom underpinned other share prices.

“This will be a sustainable recovery. I think there’s going to be kind of a roaring twenties again,” Rogers said, adding that the strength of the economic recovery would surprise people and challenge the Federal Reserve’s ultra-dovish monetary policy.

The US central bank is “overly optimistic that they can keep inflation under control”, he said, and higher bond market interest rates would reduce the value of future earnings for highly popular growth stocks such as tech companies and for the kinds of speculative companies coming to market in initial public offerings or via deals with Spacs.

“Spacs are a sign that growth stocks are topping. A signal that the market is frothy,” said Rogers, a self-styled contrarian and famed for his Patient Investor newsletter for clients that debuted in 1983.

Value investing is based on identifying cheap companies that are trading below their true worth, an approach long espoused by Warren Buffett. Value stocks and those sensitive to the economic cycle boomed after the internet bubble burst in 2000, but the investment strategy has been well beaten over the past decade by fast-growing stocks, led by US tech giants. 

“We’ve been looking like the dinosaurs for so long,” said Rogers. “We’ve been waiting for that booming economic recovery since 2009.”

Proponents of value investing believe that the combination of expensive growth stock valuations and a robust recovery from the pandemic will cause a significant switch between the two investing approaches.

Higher bond market interest rates reduce the relative appeal of owning growth stocks based on their future earnings power.

When 10-year bond yields rise, “growth stocks look way, way too expensive versus value,” said Rogers. “Value stocks are going to come out of the recovery very strong, they’re going to have a tailwind from an earnings perspective. Their earnings are going to be here and now, not 20, 30 years down the road.”

The Russell 1000 Value index outperformed the equivalent growth index by 6 percentage points in February, rising 5.8 per cent versus a drop of 0.1 per cent for the growth index. That was the biggest outperformance for value since March 2001, according to analysts at Bank of America.

“Although rising rates triggered the rotation, we see a host of other reasons to prefer value over growth,” the analysts wrote last week, “including the profit cycle, valuation, and positioning that can drive further outperformance.”

Rogers said he expected higher overall stock market volatility from rising interest rates this year but value should reward investors as it did “20 years ago once the internet bubble burst”. Ariel is bullish on “fee generating financials” and Rogers said preferred names included KKR, Lazard and Janus Henderson, while it was also bullish on traditional media, including CBS Viacom and Nielsen.

Chicago-based Ariel is one of the few large black-owned investment companies in the US, with $15bn of assets under management. It manages the oldest US mid-cap value fund, dating from 1986. 

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High-priced tech stocks sink further into bear market territory




Some of the hottest technology stocks and funds of recent months have fallen into bear market territory and investors are betting on more turmoil to come, as rising bond yields undermine the case for holding high-priced shares.

A Friday afternoon stock market rally notably failed to include shares in Tesla and exchange traded funds run by Cathie Wood, the fund manager who has become one of the electric carmaker’s most vocal backers.

Shares in Tesla fell 3.6 per cent on Friday to close below $600 for the first time in more than three months, although it had been down as much as 13 per cent at one point. The stock is down 32 per cent from its January peak, erasing $263bn in market value.

Wood’s $21.5bn flagship Ark Innovation ETF — 10 per cent of which is invested in Tesla shares — also closed lower on Friday. It is now down 25 per cent and in a bear market, defined as a decline of more than one-fifth from peak.

Clean energy funds run by Invesco, which were last year’s best-performing funds, are also in bear market territory, along with some of the highest-flying stocks in the technology and biotech sectors.

“Bubble stocks and many aggressively priced US biotechnology stocks have been the hardest hit segments of the equity market,” said Peter Garnry, head of equity strategy at Saxo Bank.

The tech-heavy Nasdaq Composite index fell into correction territory — defined as a decline of more than 10 per cent from peak — earlier this week but rebounded 1.6 per cent on Friday as bond yields stabilised.

The yield on 10-year US Treasuries yield briefly rose above 1.6 per cent early in the day after a robust employment report for February buoyed confidence in a US economic recovery. Yields were less than 1 per cent at the start of the year.

Rising long-term bond yields reduce the relative value of companies’ future cash flows, hitting fast-growing companies particularly hard.

These type of companies figure prominently in thematic investing funds run by Wood at Ark Investments. The performance of Ark’s exchange traded funds has abruptly reversed after they recorded huge inflows and strong gains for much of the past 12 months.

“The speculative tech trade is in various stages of rolling over right now,” said Nicholas Colas, co-founder of DataTrek, a research group.

Bar chart of  showing Hot stocks and funds enter bear market territory

RBC derivatives strategist Amy Wu Silverman said investors were still putting on hedges in case of further declines in high-flying securities, including options that would pay off if Tesla and the Ark Innovation fund drop in value.

The number of put options on the Ark fund hit an all-time high on Thursday, according to Bloomberg data. By contrast, demand for put options on ETFs such as State Street’s SPDR S&P 500 fund — which reflects the broader stock market — have fallen as stocks have dropped.

Demand for options normally slides as a stock or ETF slumps in value, given there was “less to hedge, since you got your down move”, Silverman said. The elevated put option activity on speculative tech stocks and funds was “suggesting investors believe there is more to go”, she said.

Even after the declines, stocks in the Ark Innovation ETF remain highly valued, with a median price-to-sales ratio of 22 versus 2.5 for the broader stock market according to Morningstar, the data provider.

Two of the fund’s other big holdings, the streaming company Roku and the payments group Square, were also lower on Friday, extending recent declines.

Ark’s other leading ETFs have also retreated sharply as air has come out of Tesla and other hot stocks. Tesla is the largest holding in Ark’s $3.3bn Autonomous Tech and Robotics fund and its $7.2bn Next Generation Internet ETF.

Wood has also taken concentrated holdings in small, innovative companies. Ark holds stakes of more than 10 per cent in 26 small companies across its five actively managed ETFs, according to Morningstar.

“These large stakes raise concerns around capacity and liquidity management,” said Ben Johnson, director of passive funds research at Morningstar. “The more of a company the firm owns, the more difficult it will be to add to or reduce its position without pushing prices against fund shareholders.”

Ark did not respond to a request for comment. The Ark Innovation ETF is still sitting on a performance gain of 120 per cent for the past year. It bought more shares in Tesla when the carmaker’s shares began falling last month.

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Powell inflation remarks send Asian stocks lower




Asian stocks were mostly lower after a rout in US Treasuries spread to the region after comments from Jay Powell that failed to stem inflation concerns in the US.

Hong Kong’s Hang Seng dropped 0.3 per cent following the remarks by the chairman of the US Federal Reserve while Japan’s Topix rose 0.1 per cent and the S&P/ASX 200 fell 0.8 per cent in Australia.

China’s CSI 300 index of Shanghai- and Shenzhen-listed stocks dropped as much as 2 per cent before pulling back to be down 0.5 per cent by the end of the morning session, after Beijing set a target of “above 6 per cent” for economic growth in 2021.

Premier Li Keqiang hailed China’s recovery from an “extraordinary” year and said the government wanted to create at least 11m urban jobs at a meeting of the National People’s Congress, the annual meeting of the country’s rubber-stamp parliament.

“A target of over 6 per cent will enable all of us to devote full energy to promoting reform, innovation and high-quality development,” Li said, adding that Beijing would “sustain healthy economic growth” as it kicked off the new five-year plan.

Analysts were less sanguine on China’s economic outlook, however, pointing to the markedly lower growth target relative to recent years.

“There is, in fact, not much surprise from the government work report except for the super-low GDP target,” said Iris Pang, chief economist for Greater China at ING, who estimated growth would be 7 per cent this year. “This makes me feel uneasy as I don’t know what exactly the government wants to tell us about the recovery path it expects.”

The mixed performance from Asia-Pacific stocks came after Powell failed to alleviate fears that the US central bank was reacting too slowly to rising inflation expectations and longer-term Treasury yields, which rise as bond prices fall.

Powell on Thursday said he expected the Fed would be “patient” in withdrawing support for the US economic recovery as unemployment remained well above targeted levels. But he added that it would take greater disorder in markets and tighter financial conditions generally to prompt further intervention by the central bank.

“As it relates to the bond market, I’d be concerned by disorderly conditions in markets or by a persistent tightening in financial conditions broadly that threatens the achievement of our goals,” Powell said.

Yields on 10-year US Treasuries jumped 0.07 percentage points to 1.55 per cent following Powell’s remarks. In Asian trading on Friday, they climbed another 0.02 percentage points to 1.57 per cent. The yield on the 10-year Australian treasury rose 0.07 percentage points to 1.83 per cent

“Based on our growth forecast, longer-term rates will likely rise for the next few quarters — but more slowly,” said Eric Winograd, a senior economist at AllianceBernstein. “And we think the Fed is prepared to push in the other direction if rates rise too far, too fast.”

The S&P 500, which closed Thursday’s session down 1.3 per cent, was tipped by futures markets to fall another 0.1 per cent when trading begins on Wall Street. The FTSE 100 was set to fall 0.8 per cent.

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