For many growth companies, high interest rates have proven to be a drag on their earnings, but that has not been the case for CME Group (NASDAQ:CME), which runs the world’s largest derivatives marketplace.
The operator of the Chicago Mercantile Exchange, Chicago Board of Trade and New York Mercantile Exchange posted record results in 2023, largely due to a surge in the trading volume of interest-rate products.
The stock was up almost 4% on Wednesday to $215 per share, lifted by its record results and better-than-expected earnings. Here’s why it did so well.
Record-setting year, driven by uncertainty
CME Group’s record-setting year was capped off by a fourth quarter that saw its revenue climb 19% to $1.439 billion and net income jump about 28% to $815 million, or $2.24 per share.
For the full year, the firm had record revenue of $5.6 billion, up 12% year over year, while its net income was $3.2 billion or $8.87 per share, up 18.5%. On an adjusted basis, CME Group’s net income was $3.4 billion or $9.35 per share.
The firm’s revenue was juiced by a record average daily volume (ADV) of 24.4 million contracts trading on its platform last year. The fourth quarter saw an ADV of 25.5 million contracts, up 17% year over year. The ADV in the fourth quarter was the highest ever for a Q4 and 33% more than the recent five-year average for a fourth quarter.
While CME Group had double-digit ADV growth in four of the six asset classes on its platform, interest-rate products were by far the biggest. CME Group is the largest marketplace for interest-rate derivatives trading, so in a year when interest rates were on the rise, trading volume also rose.
In the fourth quarter, the ADV of interest-rate products spiked 36% to 13.3 million contracts, the highest 4Q ADV on record. The bulk of that was in Treasury futures and options, as ADV there climbed 44% to a record 7.7 million.
While rising interest rates certainly led to an increase in trading volumes, CME Group chairman and CEO Terrence Duffy explained that it is really the uncertainty that drives volumes.
“In my 40+ years in the industry, I’ve observed that regardless of whether rates are going up or down, our volumes are typically higher during periods when the change of rates is uncertain, as is the case today,” Duffy said on the Q4 earnings call. “I’ve never seen such a disparity in opinions on what the Fed may or may not do, and I believe that is a tailwind for CME Group and our rates products.”
Duffy elaborated on this “age of uncertainty” by saying that interest-rate volume was up 16% in the first half of 2023 with four interest-rate hikes. That pace accelerated in the second half of the year, when there were no rate hikes, as the interest rate ADV was up 24%.
More uncertainty ahead
Thus, while interest rates are expected to come down in 2024, much uncertainty remains about the economy, inflation, the Federal Reserve and the direction of interest rates. This should bode well for CME Group.
In fact, the uncertainty has already resulted in a record January, with ADV of 25.2 million contracts up 16% from the previous January. The ADV for interest-rate products was 13.1 million, a January record.
“All that being said, 2024 is still very much in the Age of Uncertainty and our products remain critical risk management tools for our customers,” Duffy said on the call.
CME did not offer any revenue or earnings guidance in the presentation, but it does expect $1.585 billion in adjusted operating expenses, up slightly from $1.526 billion in 2023, and full-year capital expenditures of $85 million.
However, based on its very reasonable valuation with a price-to-earnings (P/E) ratio of 24 and a forward P/E of 22, coupled with continued uncertainty and punctuated by its record January volumes, CME Group should have another strong year in 2024.
