CME Group Fundamental Analysis Market Education€¦ · CME Group Fundamental Analysis Market...
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CME Group Fundamental Analysis Market Education Understanding A Market’s Economic Environment
Transcript of CME Group Fundamental Analysis Market Education€¦ · CME Group Fundamental Analysis Market...
CME Group Fundamental Analysis
Market Education
Understanding A Market’s
Economic Environment
CME Group Fundamental
Analysis Section I
2
Goal Of Section
• Develop a framework for thinking about fundamental
analysis, the trading of markets based on economic and
industry information
• Understand what its limitations are
• Understand how it relates to other forms of analysis
• Understand where in the economic and political
environment fundamental news develops and where to
start looking for it
CME Group Fundamental
Analysis Section I
3
Introduction
• Fundamental analysis is a state of mind
• The task, then, is to interpret new
information arriving in the market as either
supporting or countering existing trends in
price
CME Group Fundamental
Analysis Section I
4
Fundamental Valuation Relationships
• All market fundamental valuations can be
stated in deceptively simple terms
• For each market, the basic relationship
invites a stream of “yes, but” objections,
and this is exactly the point
CME Group Fundamental
Analysis Section I
5
Absolute Vs. Relative Valuation
• Few markets exist in a trading vacuum
• Many market prices are inputs into other
markets’ fundamental equation
• Many markets define the risk parameters
used in other markets
CME Group Fundamental
Analysis Section I
6
Technical Vs. Fundamental
• This is a not an either-or proposition
• Timeframe is key dividing the two forms of
analysis
• Great traders use both. It raises
confidence levels when multiple
approaches agree
CME Group Fundamental
Analysis Section I
7
The Approach
• Too many traders approach fundamental
analysis from a “guess the number”
standpoint
• Most important, markets are discounting
mechanisms where expectations for a
given report have been capitalized into the
price
CME Group Fundamental
Analysis Section I
8
The Assumptions
• While market reactions go in cycles,
certain assumptions tend to remain
constant over time and define how traders
process information
• Other assumptions have changed radically
over time
CME Group Fundamental
Analysis Section I
9
Assumptions (Cont.)
• The correct question is not, “What is
important?” but rather, “What is important
today?”
• Oftentimes, all key policymakers need to
do is hint they are looking at a number or
set of numbers for a heretofore obscure
indicator to acquire a sudden and often
temporary importance
CME Group Fundamental
Analysis Section I
10
Assumptions (Cont., 2)
• Assumptions often change in intermarket
relationships
• Never assume a permanence in
relationships. Once again, it is not what is
important, it is what the market considers
to be important today
CME Group Fundamental
Analysis Section I
11
News And Reaction To News
Market news can be divided into a 2 x 2 matrix:
• News that affects both price and underlying
economic value
• News that affects price but does not affect
underlying economic value
• News that affects underlying economic value,
but does not appear to affect price, and
• News that affects neither price nor underlying
economic value
CME Group Fundamental
Analysis Section I
12
News And Reaction To News (Cont.)
• The first category generally occurs within the
context of a market reversal, a single shift in
market direction because the world has changed
• The second category generally occurs within a
trading range and produces a price reaction
soon reversed
• The third category generally occurs within an
existing trend
• The fourth category can be ignored
CME Group Fundamental
Analysis Section I
13
News Interpretations
• Markets can develop a “bad news is good”
or vice-versa syndrome
• “The price is the news” is critical. The
market will tell you how news has been
interpreted and how its sense of what is
important has changed
CME Group Fundamental
Analysis Section I
14
Policy Developments
CME Group Fundamental
Analysis Section I
15
The Economic & Policy Culture
• A culture is nothing but a set of shared
beliefs
• These are not symmetric
CME Group Fundamental
Analysis Section I
16
Monetary Policy
• Monetary policy includes both the price of
money (short-term interest rates controlled
by the central bank) and the quantity of the
money
• The target interest rates established by the
world’s principal central banks are the
single most important set of fundamentals
for financial markets
CME Group Fundamental
Analysis Section I
17
Target Federal Funds Rate’s Impact
• For years, the assumptions were simple: A
higher target federal funds rate would slow
the demand for credit
• The intentions may have been bullish, but
the results were not
CME Group Fundamental
Analysis Section I
18
The Target Rate And Key Markets
Target Federal Funds And U.S. Stock Market
0.1%
1.0%
10.0%
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rge
t F
ed
era
l F
un
ds
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400
500
600
700
800
900
1000
1100
1200
1300
1400
1500
1600
S&
P 5
00
In
de
x
Target Federal Funds
S&P 500
Target Federal Funds And U.S. Long-Term Yields
0.1%
1.0%
10.0%
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Ta
rge
t F
ed
era
l F
un
ds
75
80
85
90
95
100
105
110
115
120
125
130
Te
n-Y
ea
r N
ote
Fu
ture
, In
ve
rse
Sc
ale
Target Federal Funds
Ten-Year Note Future
Target Federal Funds And Dollar Per Euro Rate
0.1%
1.0%
10.0%
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20
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Ta
rge
t F
ed
era
l F
un
ds
0.65
0.75
0.85
0.95
1.05
1.15
1.25
1.35
1.45
1.55
1.65
US
D P
er
EU
R
Target Federal Funds
Euro & Predecessors
Target Federal Funds And Inflation Measures
0.1%
1.0%
10.0%
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10
Ta
rge
t F
ed
era
l F
un
ds
-7.0%
-5.0%
-3.0%
-1.0%
1.0%
3.0%
5.0%
7.0%
9.0%
CP
I &
PP
I, Y
ea
r-O
ve
r-Y
ea
r
Target Federal Funds
CPI, Year-Over-Year
PPI, Year-Over-Year
CME Group Fundamental
Analysis Section I
19
Fiscal Policy
• Fiscal policy refers to issues related totaxation and government spending
• The U.S. has run federal deficits as amatter of course since the mid-1960s withthe prominent exception of the late 1990s
• One assumption that has changeddrastically since the early 1980s is higherlevels of federal borrowing lead to higherinterest rates on Treasury debt
CME Group Fundamental
Analysis Section I
20
Do Federal Deficits Matter?
• The federal deficit as a
percentage of GDP fell from
the early 1980s into 2000 and
rose sharply thereafter
– The effect on inflation
measures led by 24 months
(top chart) has been almost
non-existent
– Both long- and short-term
Treasury rates (bottom chart)
fell while deficits expanded
• No one would have believed
this possible in 1980
Federal Deficits And Interest Rates
-11%
-10%
-9%
-8%
-7%
-6%
-5%
-4%
-3%
-2%
-1%
0%
1%
2%
3%
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95
19
97
19
98
20
00
20
01
20
03
20
04
20
06
20
07
20
09
Su
rplu
s/D
efi
cit
As
Pe
rce
nt
of
GD
P, In
ve
rse
Sc
ale
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
10%
11%
12%
13%
14%
15%
16%
17%
On
e-
An
d T
en
-Ye
ar
Tre
as
ury
Yie
lds
Deficit / GDP
Ten-Year Treasury
One-Year Treasury
Federal Deficits And Inflation
-11%
-10%
-9%
-8%
-7%
-6%
-5%
-4%
-3%
-2%
-1%
0%
1%
2%
3%
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19
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19
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19
77
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79
19
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00
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06
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07
20
09
Su
rplu
s/D
efi
cit
As
Pe
rce
nt
of
GD
P, In
ve
rse
Sc
ale
-3%
-1%
1%
3%
5%
7%
9%
11%
13%
15%
Y-o
-Y C
ha
ng
es
in
CP
I A
nd
Co
re P
CE
, L
ed
24
Mo
nth
sDeficit / GDP
CPI Year-Over-Year
Personal Consumption Deflator, Year-Over-Year
CME Group Fundamental
Analysis Section I
21
Current Account (Trade) Deficit
• The U.S. has run current account deficits
almost continuously since the early 1980s
• Once again, the old assumption of higher
deficits leading to a weaker dollar and
higher interest rates has collapsed over
time
CME Group Fundamental
Analysis Section I
22
Does The Current Account Deficit Matter?
• The dollar (top chart) has led
the current account deficit as a
percentage of GDP by about
two and one-half years, but the
link is not a strong one
• Long-term interest rates
(bottom chart) have almost no
connection to the current
account deficit
• Once again, it is hard to look at
these charts and believe how
strongly the opposite opinions
were held once
Current Account Deficit And Interest Rates
-6.5%
-6.0%
-5.5%
-5.0%
-4.5%
-4.0%
-3.5%
-3.0%
-2.5%
-2.0%
-1.5%
-1.0%
-0.5%
0.0%
0.5%
1.0%
1.5%
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95
19
97
19
98
20
00
20
01
20
03
20
04
20
06
20
07
20
09
Su
rplu
s / D
efi
cit
As
Pe
rce
nt
Of
GD
P, In
ve
rse
Sc
ale
2%
3%
4%
5%
6%
7%
8%
9%
10%
11%
12%
13%
14%
15%
16%
17%
Te
n-Y
ea
r T
rea
su
ry Y
ield
s
Current Account Deficit / GDP
Ten-Year Treasury
Current Account Deficit And The Dollar
-6.5%
-6.0%
-5.5%
-5.0%
-4.5%
-4.0%
-3.5%
-3.0%
-2.5%
-2.0%
-1.5%
-1.0%
-0.5%
0.0%
0.5%
1.0%
1.5%
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19
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20
00
20
01
20
03
20
04
20
06
20
07
20
09
Su
rplu
s / D
efi
cit
As
Pe
rce
nt
Of
GD
P, In
ve
rse
Sc
ale
70
75
80
85
90
95
100
105
110
115
120
125
130
135
140
145
150
155
160
165
U.S
. D
olla
r L
ag
ge
d 3
0 M
on
ths
Current Account Deficit / GDP
U.S. Dollar Lagged 30 Months
CME Group Fundamental
Analysis Section I
23
Comments On The “Twin Deficits”
• Why did the previous assumptions
regarding deficits collapse?
• A set of assumptions held throughout the
trading culture can become self-defeating.
They were not intrinsically correct; they
were simply held to be correct at the time
CME Group Fundamental
Analysis Section I
24
Legislative & Regulatory Changes
• As laws and regulations define the rules
under which all commerce occurs, every
market is affected
• Change is permanent: In a representative
system of government where the freedom
to petition the government is protected, all
policies are, to a certain extent, temporary
CME Group Fundamental
Analysis Section I
25
Laws & Regulations (Cont.)
• Treaties take precedence over domesticlaw and can have significant effects ondomestic markets
• The legislative process can createuncertainties with macroeconomic effects
CME Group Fundamental
Analysis Section I
26
Laws & Regulations (Cont., 2)
• The financial services industry has been
regulated heavily since the 1930s
• The financial crisis of 2007-2009 has
prompted a set of legislative and
regulatory changes that affect all
participants and institutions
CME Group Fundamental
Analysis Section I
27
Non-U.S. Laws & Regulations
• The non-U.S. legal & regulatory
environment can be just as important
• European Union anti-trust policies have
affected mergers & acquisitions and hence
the value of U.S. stock indices
CME Group Fundamental
Analysis Section I
28
International Economics & Politics
• Currency traders must, by definition, live in
an international environment
• Currencies in turn affect all markets,
whether global or not, as exchange rates
also affect the allocation of resources
within a domestic economy
CME Group Fundamental
Analysis Section I
29
International Economics & Politics (Cont.)
• The relative performance of
national stock markets (top
chart) increasingly follows
currency rates
• Those currency rates in turn
are affected by and affect note-
horizon interest rate
differentials (bottom chart)
• The movements of currencies
thus affect all capital markets
and therefore the allocation of
resources within the respective
economies
Relative Equity Returns Increasingly Follow Currencies
0.82
0.87
0.92
0.97
1.02
1.07
1.12
1.17
1.22
1.27
1.32
1.37
1.42
1.47
1.52
1.57
1.62
Ja
n-9
9
Ju
n-9
9
De
c-9
9
Ma
y-0
0
No
v-0
0
Ap
r-0
1
Oct-
01
Ma
r-0
2
Se
p-0
2
Fe
b-0
3
Au
g-0
3
Ja
n-0
4
Ju
l-0
4
De
c-0
4
Ju
n-0
5
De
c-0
5
Ma
y-0
6
No
v-0
6
Ap
r-0
7
Oct-
07
Ma
r-0
8
Se
p-0
8
Fe
b-0
9
Au
g-0
9
Ja
n-1
0
Ju
l-1
0
US
D P
er
EU
R
60%
65%
70%
75%
80%
85%
90%
95%
100%
105%
110%
115%
120%
125%
130%
Rela
tive P
erf
orm
an
ce o
f U
.S. T
o E
uro
pean
Eq
uit
ies
Jan
. 8, 1999 =
100%
, In
vers
e S
cale
EUR
Relative Stock Performance
The Euro And Note-Rate Differentials
-200%
-175%
-150%
-125%
-100%
-75%
-50%
-25%
0%
25%
50%
Ja
n-9
9
Ju
n-9
9
De
c-9
9
Ma
y-0
0
No
v-0
0
Ap
r-0
1
Oct-
01
Ma
r-0
2
Se
p-0
2
Fe
b-0
3
Au
g-0
3
Ja
n-0
4
Ju
l-0
4
De
c-0
4
Ju
n-0
5
De
c-0
5
Ma
y-0
6
No
v-0
6
Ap
r-0
7
Oct-
07
Ma
r-0
8
Se
p-0
8
Fe
b-0
9
Au
g-0
9
Ja
n-1
0
Ju
l-1
0
[US
D -
EU
R]
/ U
SD
0.80
0.85
0.90
0.95
1.00
1.05
1.10
1.15
1.20
1.25
1.30
1.35
1.40
1.45
1.50
1.55
1.60
1.65
US
D P
er
Eu
ro, In
ve
rse
Sc
ale
2 Year
5 Year
10 Year
USD Per EUR
CME Group Fundamental
Analysis Section I
30
International Economics & Politics (Cont., 2)
• National policies on currencies are never
constant
• The experience with floating exchange
rates since 1971 has been no one is
happy with their or key trading partners’
currency levels for very long
CME Group Fundamental
Analysis Section I
31
International Organizations
• International cooperation at the head-of-
government level has become more frequent
and important in recent years.
• Supranational institutions such as the Bank for
International Settlements have set the standards
for bank capitalization
• The International Monetary Fund has
transformed its mission to include providing
critiques of national economic policy
CME Group Fundamental
Analysis Section I
32
The Largest Global Change
• The emergence of the so-called BRIC
quartet (Brazil, Russia, India and China) is
the largest change in the global economic
landscape since the emergence of the
United States between the Civil War and
World War I
CME Group Fundamental
Analysis Section I
33
China’s Expanding Role In U.S. Trade
• China’s expanding role in the
Federal Reserve’s import (top
chart) weights for the U.S.
dollar has accelerated at the
expense of Japan and Canada
• China’ share of export weights
(bottom chart) has been
slower, but it also is coming at
the expense of Japan
• Both physical and financial
commodity traders increasingly
will be reacting to trans-Pacific
as opposed to trans-Atlantic
developments
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
20
09
20
07
20
05
20
03
20
01
19
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19
97
19
95
19
93
19
91
19
89
19
87
19
85
19
83
19
81
19
79
19
77
19
75
19
73
Total Import Weights For U.S. Dollar
Japan
Mexico
Eurozone
China
Canada
All Others
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
20
09
20
07
20
05
20
03
20
01
19
99
19
97
19
95
19
93
19
91
19
89
19
87
19
85
19
83
19
81
19
79
19
77
19
75
19
73
Total Export Weights For U.S. Dollar
China
Japan
Mexico
Eurozone
Canada
All Others
CME Group Fundamental
Analysis Section I
34
Industry Economics
• Many physical commodities are a process
input and are not a final market
• Prices used to rise and fall in general
response to processing margins, but the
growth of commodity index investments
opened up the previously rare contango
storage trade
CME Group Fundamental
Analysis Section I
35
Sample U.S. Crude Oil Indicators
• The Gulf Coast 2-1-1 refining
margin measures refining
profitability; changes in this
margin lead the spread
between sweet and sour crude
oil (top chart)
• The traditional backwardation,
or premium of first to second
month futures, shifted into
frequent contango once
commodity index investments
helped push back-month
futures prices higher.
Inventories grew in response
Inventories Rise And Fall With WTI Contango
270,000
280,000
290,000
300,000
310,000
320,000
330,000
340,000
350,000
360,000
370,000
380,000
390,000
400,000
19
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19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
Inv
en
tori
es
, 0
00
Ba
rre
ls, In
ve
rse
Sc
ale
-21.0%
-18.5%
-16.0%
-13.5%
-11.0%
-8.5%
-6.0%
-3.5%
-1.0%
1.5%
4.0%
6.5%
9.0%
11.5%
14.0%
[Mo
nth
1 -
Mo
nth
2]
/ M
on
th 2
Inventories
Backwardation
The Sweet-Sour Spread And Second Month Crack SpreadA 96 Trading Day Leading Relationship
3.0
4.5
6.0
7.5
9.0
10.5
12.0
13.5
15.0
16.5
18.0
19.5
21.0
22.5
24.0
Ja
n-0
2
Ap
r-0
2
Ju
n-0
2
Se
p-0
2
De
c-0
2
Ma
r-0
3
Ju
n-0
3
Se
p-0
3
De
c-0
3
Ma
r-0
4
Ju
n-0
4
Au
g-0
4
No
v-0
4
Fe
b-0
5
Ma
y-0
5
Au
g-0
5
No
v-0
5
Fe
b-0
6
Ma
y-0
6
Au
g-0
6
No
v-0
6
Fe
b-0
7
Ma
y-0
7
Au
g-0
7
No
v-0
7
Fe
b-0
8
Ma
y-0
8
Ju
l-0
8
Oct-
08
Ja
n-0
9
Ap
r-0
9
Ju
l-0
9
Oct-
09
Ja
n-1
0
Ap
r-1
0
Ju
l-1
0
Se
co
nd
Mo
nth
2-1
-1 C
rac
k S
pre
ad
, $
/Ba
rre
l
-1
0
1
2
3
4
5
6
7
8
9
10
11
WT
I -
WT
S, $
/Ba
rre
l L
ed
96
Da
ys
2-1-1 Crack Spread
Midland Sweet-Sour
CME Group Fundamental
Analysis Section I
36
Financial Health Of Key Institutions
• One hard lesson repeated frequently in the
last two decades is a large institution that
runs into trouble creates problems for
others
• The leveraged exposures of large financial
institutions and their intertwined exposures
create rapid transmission of distress
CME Group Fundamental
Analysis Section I
37
Trading Technology
• Trading used to be a person-to-personbusiness where “know your customer” wasliterally common
• The rise of algorithmic and high-frequencytrading has taken the person-to-personchecks out of the system
• Fragmented liquidity pools, especially inthe securities arena, may have contributedto the May 2010 “flash crash”
CME Group Fundamental
Analysis Section I
38
Trading Technology (Cont.)
• Expanded trading hours and the greater stamina and
order-processing capacity of electronic trading systems
have allowed a greater distribution of trades over time
• Combined with the growing importance of Asian and
Latin American markets, these expanded hours are both
creating greater opportunities and placing greater
burdens on trading organizations
• Fundamental information can arrive at any time from any
source and be reacted to instantly and in commercial
size in a way impossible previously
CME Group Fundamental
Analysis Section I
39
Technological Developments
• Technological breakthroughs in commodities often fall
into the category of news that affects price without
affecting value
• Corporations can and do change fairly rapidly with
technological innovations; these often have a direct and
lasting impact on stock indices
CME Group Fundamental
Analysis Section I
40
Investment Cycles
• The adage “buy-low, sell-high” tends to be
honored in the breach at the industry
economic level as well
• Agricultural production and planting
intentions often lag prices; a period of high
prices is followed by large planting
intentions and a subsequent price decline
as new supplies come to market
CME Group Fundamental
Analysis Section I
41
Industrial Organization Response
• Industries facing large capital investment
needs often find it easier to acquire
competitors first
• These consolidations are enabled by
technological developments such as
enterprise software systems, global supply
chain management and Internet-based
management
CME Group Fundamental
Analysis Section I
42
Weather: The Constant Fundamental
• Not only do weather events affect energy consumption,crop yields, livestock weights and other obviouscommodity-related markets, weather increasingly affectspatterns in seasonal employment, retail sales,construction activity and other macroeconomic data
• Catastrophic weather events such as hurricanes canaffect regional economies for years; the effects ofoutsized hurricane seasons in 2004-2005 are still beingfelt
• Many hedge funds and investment banks employ staffmeteorologists now and trade on both short- and long-term weather forecasts
CME Group Fundamental
Analysis Section I
43
Seasonality And Cycles
• Agricultural futures markets arose tosmooth out the effects of the seasonalcrop cycles
• As in the case of weather factors,seasonal factors are quite dominant inboth agricultural and energy markets
• Many important economic numbers, suchas employment and retail sales, areadjusted seasonally
CME Group Fundamental
Analysis Section I
44
When In Rome…
…Do as the Romans do. While the first step in
successful fundamental analysis may be a deep
understanding of a market’s supply and demand
balances, industry economics, technological change and
the external political and global environment, all is for
naught if the market’s assessment of what is important
changes.
A market must be followed on a real-time basis to see
how it reacts to new information. This allows you to get
in synch with what is driving the price.
CME Group Fundamental
Analysis Section I
45
Be A Skeptic
Many explanations of what is important are available forfree and are well worth the price. The first explanationoften does not pass analytic muster. The key principle isa reason must hold at all times and under allcircumstances except when it is overwhelmed byanother factor operating.
Financial markets are data-rich, and relationships areeasy to test. Always test the conventional wisdom; youwill find it is wrong a great deal of the time. This is theonly way you can get ahead of the market instead ofreacting to news.
![CME Group Inc. (CME) April 17, 2020CME Group Global Trading Platform as of April 17, 2020 Page 3 product categories and global footprints [6]. For example, in 2018, CME Group acquired](https://static.fdocuments.us/doc/165x107/60a2b5b6610d036f893f96e2/cme-group-inc-cme-april-17-2020-cme-group-global-trading-platform-as-of-april.jpg)
