Why This Industry is Crushing the Market

The S&P 500 is up some 19% year to date while the Nasdaq Composite has surged more than 36% this year. The technology sector has been a huge driver, bouncing back from a terrible 2022.

However, one industry within the financial sector has quietly produced huge returns this year as well: financial data and exchanges. This industry includes companies that run stock exchanges and provide financial data and analytics, primarily to institutional investors.

Of the dozen or so major companies in this industry that are publicly traded, about half of them are beating the benchmark, led by crypto exchange Coinbase (NASDAQ:COIN). Other top performers are CBOE Global Markets (NASDAQ:CBOE), Moody’s (NYSE:MCO), Morningstar (NASDAQ:MORN), CME Group (NYSE:CME), and Standard & Poor’s Global (NYSE:SPGI).

Here is an overview of what has driven their success and where they may be headed.

Coinbase rockets 280% higher

While these stocks are all in the same general industry, they cover different parts of it, so their stories are different. Take Coinbase, for example. This crypto exchange stock is up a whopping 280% YTD, trading at around $137 per share.

However, it lost 86% of its value in 2022, crashing down from a high of around $350 per share in November 2021. The gains are mostly due to a bounce-back year for bitcoin and ether, the two largest cryptocurrencies, and paused interest rate hikes have helped.

There is also anticipation for the likely approval of the first bitcoin exchange-traded funds (ETFs), but there remains a lot of uncertainty in the crypto space.

Coinbase’s net revenue was up 8% year over year to $623 million in the third quarter but down 6% from the second quarter. More importantly, it narrowed its net losses to just $2 million. These are solid and improving numbers but perhaps not enough to justify the big returns.

The crypto winter that we saw in 2022 may be over, but there remains tons of uncertainty and volatility in the crypto space, which has brought down some of Coinbase’s competitors. Given its sharp price increase in contrast with its tepid revenue generation, it’s currently a bit overvalued, so I would be reluctant to jump on it now. There are better investments elsewhere in this space.

CBOE Global Markets and CME Group are two of them. They are two of the leading derivatives exchanges. CBOE is up about 40% YTD while CME is up roughly 25%. These two stocks have been driven by higher trading volumes on their exchanges.

In November, CME Group set a record for the month with an average daily volume (ADV) of 28.3 million derivatives contracts trading on its platform, up 21% year over year. In the most recent quarter, it saw revenue jump 9% year over year and net income rise 10%.

Likewise, CBOE saw a surge in volume in its most recent quarter, leading to record net revenue that rose 9% year over year and a 38% increase in earnings per share (EPS).

Both are reasonably valued, but of the two, CME has higher upside potential with a larger presence in Treasury and bond futures trading. Those markets should continue to perform well in a high-interest-rate environment.

Moody’s, Standard & Poor’s, and Morningstar

Two other big gainers in this space are Moody’s and Standard & Poor’s Global. These two companies are similar in that they are the two leading credit-rating agencies in the U.S., and they both have robust data, analytics and market intelligence businesses. S&P also has its index business as the owner of the S&P 500 and many other market indexes. Moodyʻs stock is up 35% YTD while S&P Global has returned 25%.

Both of these companies benefited from an increase in debt issuance, while their respective analytics and market intelligence businesses continue to grow through almost any type of economic cycle as the markets become more and more complex.  

Morningstar is similar in that it provides investment research to individuals and institutions and credit-ratings services, although on a much smaller scale than S&P and Moodyʻs. In addition, it has an investment management arm.

In its most recent quarter, Morningstar saw its revenue climb 10% and net income jump to $39 million from a $9 million net loss a year ago. Its stock price is up about 28% YTD, and because its products and services are tied to the markets, its stock price typically moves with it.

Moodyʻs and Standard & Poorʻs hold such dominant positions in their industry that they are pretty much always going to be solid buys. However, Standard & Poorʻs looks like the better option of the two right now, given its more diversified revenue streams and market dominance in several of them.

Overall, the best buys in this group of stocks look like Standard & Poorʻs and CME Group. The only one that I would probably avoid right now is Coinbase.