 Hello, everybody. My name is Eric Norland. I'm senior economist with CME Group. I would like to welcome you to this webinar. Yeah, with my colleague David Gibbs also from CME Group. And of course, thank everybody at Tick Mill, as well as my colleagues at CME Group who gave us the opportunity to set this up to talk about a lot of very, very exciting trends that are happening in global equity markets and interest rate markets and how those two sets of markets are very, very closely interlinked. My role in the webinar will be to talk about the economy, the macroeconomic aspects of what's going on, what might happen to the equity markets in the future. And then my colleague David Gibbs, who works on our education team, will be able to delve into the details of how all of these futures contracts work, how potential trading strategies could be set up. Now bear in mind, we do have a lot of disclaimers on this presentation. The first set of disclaimers comes from Tick Mill itself. They've asked me to read the disclaimer out loud at the beginning of the webinar. The disclaimer says the material provided is for informational purposes only and should not be considered as investment advice. The views, information or opinions expressed in the text belong solely to the author and not to the author's employers, organization, committee or other group or individual or company. There is an additional risk warning which states that trading futures and options comes with a high risk of losing money due to leverage. Always ensure that you understand these risks before trading. In addition to their disclaimer, CME also has its own disclaimers basically saying that there is no investment advice given or intended. This webinar is really only for educational purposes. Then of course we have our own very long disclaimer that basically describes CME's organizational form and how we are regulated in various parts of the world including the United States and various European countries. So with that in mind, I thought I would start with what I think is the most extraordinary set of developments that we have seen in the economy in many, many years. We see this here in Europe. I'm based in London. Interest rates here of course are soaring. We've seen the Bank of England raise interest rates from a quarter point to four percent. We've seen the European Central Bank raise rates from zero to three percent. Both of these central banks by all appearances have further to go. There were a number of economists or I should say members of the Monetary Policy Committee at the Bank of England who spoke to the press today saying that they were thinking of another 50 basis point move at their upcoming meeting this March. What's extraordinary about all of this is that the European banks are still so far behind the curve. They still have interest rates way below the level of inflation. Inflation at the core level in Europe is at five percent. In England it's over six percent and the banks aren't even getting interest rates within 200 basis points of that at the moment. It's a little bit of a different story in the United States. This will be kind of the main topic of this presentation. The United States, as I'm sure many of you know, also has its highest rate of inflation since the early 1980s. And in the United States, the Federal Reserve has been a bit more aggressive than the European Central Banks have. They've raised interest rates so far by 450 basis points. The market, as we will discuss, is pricing that they probably have three more 25 basis point moves that will likely take them to around five and three-eighths percent, bringing rates basically in line with where they were on the eve of the global financial crisis. Now the global financial crisis, as we know, was a very, very rocky period for the equity market to put it politely. Between the market's peak in October 2007 and its bottom in March 2009, the S&P lost 60 percent of its value. So I think that there's a lot of potential for extreme volatility in equity markets that could result from all of these rate increases. But what's even more astonishing, I think, is here in Europe and also in the United States, it's not just the amount of rate hikes, it's the speed at which they have happened. It's truly extraordinary. The last time we had more rate hikes in a 12-month period in the United States was back in 1981. You have to go back 42 years to find any comparable period in U.S. history. But there's been a lot of economic changes since the early 1980s and even a lot of changes since the financial crisis began in 2007. And one of those big changes is the level of debt and leverage in economies. Debt levels have been increasing all over the world. Back in 1981, the last time the central bank in the U.S. hiked rates as much as they have this time, the debt levels were less than half of where they are today. Total public and private sector debt in the United States in 1981, when the Fed last raised rates this much or more, was 130% of GDP. Now it's 260%. What that means to me is that the consequences of rate hikes are twice as big today as they were back then because we have tremendous amounts of debt and leverage in the economy. Now the debt and leverage didn't matter much during the last decade. Why? Because interest rates were zero. When interest rates are zero, it doesn't really matter how much debt you have if you don't have to pay anything to finance it. But now the cost of financing that debt is extremely high. And not just here in the U.S., it's high throughout Europe as well. And this could create a lot of volatility on both sides of the Atlantic and our equity markets, bond markets, as well as even commodity markets. Which we'll talk about in some of our future presentations, but not so much today. Now one of the big questions I've been hearing is, well, given that we've raised rates so much, why is the economy not already in a recession? And indeed, if you've been paying attention to the economic data over the last few weeks, you know that we're kind of in the opposite of a recession right now. We saw explosive growth in employment in the month of January. We added half a million new jobs in one month. We just got consumer spending data earlier this week showing that Americans increased their spending 3% in the month of January. A tremendous monthly increase. We also got somewhat stronger than expected inflation data. So one of the questions I'm hearing a lot is, well, given all the rate hikes, you know, does this mean that monetary policy is not having any effect? And it doesn't mean we shouldn't be worried. And a very short answer to this question is no. We should be very, very concerned about the degree to which the Fed has moved policy. We should be concerned as, you know, participants in the economy, but also as investors in equities, bonds, and in other kinds of financial or commodity assets. So what's going on here? Well, there, one of the most famous phrases in economic history is that there are long and variable lags between monetary policy changes and when those changes affect the economy. And so economists often estimate that when the Fed or any other central bank moves policy, it takes typically six to 24 months to impact the economy. And you can see this very clearly in this little table here. If you go back to say the last three recessions, we'll talk about the last four recessions. I'm going to skip the one in 2020, because the 2020 recession to my mind is a little bit artificial or actually very artificial. It happened primarily because of pandemic lockdowns. We don't know what would have happened to the economy had the pandemic not happened. So let's go back to June 2006. So if we just go back here to this previous chart over here, you can see in 2004 to 2006, the Fed hiked rates 425 basis points. So they stopped hiking rates in June 2006. And guess what? The economy was just fine. It was just fine in July 2006 and August 2006. In fact, it was just fine even in the first half of 2007. It kept growing. It wasn't really until the summer of 2007 that the very first problems really became apparent. And the economy did not officially fall into a recession until December 2007. That was 17 months after the central bank stopped hiking rates. Now the Federal Reserve, according to our Fed funds futures, probably won't stop hiking rates until June. So it might be that we don't have a recession until maybe the end of 2024. But don't think for a minute that all these rate hikes, which by the end of the cycle could be over 500 basis points of rate hikes are somehow not going to have an effect on the economy. You go back a little bit further to May 2000. The Fed did its last rate hike. The economy continued to grow until February 2001. It did not have a recession until March 2001. That was 10 months later. We go way back to the previous recession. The Fed stopped hiking rates in February 1989. We did not have a recession until July 1990. 17 months after the Fed was done hiking. So yeah, the economy right now is booming, but this is very treacherous times for investors, policy makers, and for economists. Because right now we're in the lag time between a massive tightening cycle and when that tightening cycle is eventually felt by the economy. Now, one of the big questions facing the Fed is what are they going to do about inflation? Well, the problem that the Fed is facing right now and the bond market is facing has to do with its own pricing for inflation. The bond market earlier this year, I was pricing what some people started to call immaculate disinflation. The idea that inflation was just going to go away by itself with no help. If you go back to even three weeks ago, the bond market was pricing that this year we're going to have 2% inflation. So think about that. We had 8% inflation last year, 2% this year, just like no transition. It was just going to happen like that. Well, the bond market started to change its view in the last couple of weeks as a result of some of these strong numbers. So now the bond market is pricing around 3% inflation for the next year and then around 2.25% inflation for the year after that. But one of the questions we have to ask ourselves is, is this realistic is pricing? Well, when you look at the interest rate markets, the interest rate markets have changed their views a lot. So we spoke a minute ago about that blowout employment number that we got earlier this week. Earlier this month showing on, it was two weeks ago today showing that we had created half a million new jobs in January, quite unexpectedly. Since then we got the strong retail sales number higher than expected inflation numbers and all of this has pushed markets expectations for interest rates higher. The market still now thinks that the Fed is going to hike rates three times going to finish its rate hikes in June, keep rates kind of on hold maybe until September or December or so and then it's going to start slashing interest rates and it's going to eventually put interest rates down below 4%. Now this is a big change a few weeks ago, the market thought they cut interest rates to below 3%. But all of this has created a little bit of rockiness in the equity market these last few days or the equity market has started to sort of teeter a bit. It was investors start to lose a little bit of confidence. So when you look at the equity market it's I think in a very, very perilous state. It's perilous for I think two reasons. First it's overvalued and secondly it depends on low interest rates and low inflation. So let's talk about its valuation. Here we have in black the S&P 500's market capitalization as a percentage of gross domestic product. You can see it's still 140% of GDP. Now it's down a year ago at the beginning of 2022 it was at 180% of GDP which was its highest level since at least 1929. Now it's down to 140% but that's still very richly valued. Now the other thing you see on this chart is the yield of a 10 year US Treasury and so what you can see more or less in this chart is that there is some sort of inverse relationship between the level of bond yields and the valuation of the equity market. When the equity market actually when bond yields are at very low yields like they were during the 1950s and 60s and like they have been for much of the last couple of decades the equity market can support very, very high levels of valuation. By contrast when bond yields are higher like they were during the 1970s and 1980s the equity market supports very, very low levels of valuation. In the early 1980s when the equity market hit bottom it was valued at 30% of GDP. So think about that we're at 140% now if we go back to 30% that implies roughly a 75% decline in the value of the equity market. I'm not saying it's going to happen but it could happen if inflation does not come under control. And so the threat here is that if inflation does not come down that bond yields could continue to rise just like they did during the 1960s and 1970s and during the 60s and 70s especially the late 60s throughout the 70s into the early 80s the equity market performed very, very badly it lost 70% of its value relative to inflation. Now another thing that makes me nervous about equities is their dependence on quantitative easing. So the way in which I'm going to show this is by using one of CMEs lesser known products product is mainly aimed at institutional investors but it's interesting for everybody to look at even if you don't trade it and that's S&P annual dividend futures and so what these futures show is they show an expectation for what investors think is likely to happen in the future. It's sort of like a forward curve for dividends rather than for interest rates. What's really weird about this is you still have a stock market trading at very, very high valuation levels 140% of GDP and yet when you look at the annual dividend futures which basically price the amount of index points worth of dividends it will be paid out by S&P 500 companies every year for the next 10 years. The market does not believe that between now and the end of 2033 that we're going to see any growth in corporate earnings, none. And if you inflation adjust it using the difference between classic US treasuries and treasury inflation protected securities investors actually price it earnings are likely to decline. This is really astonishing pricing. It's very, very interesting that the market could be trading at such high levels. When investors take such a bearish view of where dividends are going. Now when you look at the history of the dividend futures versus the S&P 500 things get even more curious. And so what's really curious about this is if you take the current year's annual dividend contract and you add it up with the next 10 years of expected dividends what you get here is what you see in the black line the nominal non-adjusted value of the next 10 years of dividends. And so since the beginning of 2018 so for five years now the market has been pricing that will be paying out roughly 580 S&P points of dividends over the coming 10 year period. And that hasn't really changed very much. I mean it's chopped around a little bit but overall the level hasn't moved too much. But what's really weird though since the beginning of 2018 is that the S&P went from 2,900 now to 4,200 the S&P's up over 50% and yet the market doesn't think companies earnings are going to be any better than they thought they were going to be five years ago. So in markets the way in which interest rates and equities are typically sort of joined together if you will from a theoretical perspective is that you're not really supposed to look at the nominal level of dividends just to look at the net present value. So we do here is we take that same black line we saw in the previous chart where it says nominal non-adjusted value of the next 10 years of dividends we've now recalculated it to discount it for the level of interest rates. In theory equiting markets are discounting machines. They take future cash flows and they use interest rates to discount them back into the present value. So it's interesting about this is that in 2016, 17, 18, 19 and the first three months of 2020 the S&P mostly went up and that was explained not so much because investors were becoming more optimistic about earnings but rather something else rather it was because investors were becoming more pessimistic about interest rates so interest rates were falling and they were increasing the value of future earnings but then something happened in March 2020 the two lines start to diverge they've been moving in lockstep and they start to diverge so what happened in March 2020 well that was during the early stages of the pandemic and that was when the Federal Reserve decided it was going to print $4.8 trillion worth of money and use that money to buy bonds mainly treasuries and that created a huge huge divergence where the S&P 500 started to soar eventually going to 4,700 while the net present values of dividends is actually lower now than it was for much of late 2019 what this suggests to me is that the S&P 500 is probably about 1,200 points overvalued it probably needs to come down very, very significantly back in line with the market's valuation now that doesn't mean that's going to happen this is not making a prediction for what's going to happen markets can stay out of line with reality for a long time in addition other things can happen it could be interest rates drop in which case the value of those earnings would go up could be that investors become more optimistic about future earnings so that could bring the dividends back up towards the S&P it looks like there's still a very, very wide gap here and that gap hasn't really begun to close in fact, if anything it's even widened out further during the last year so what makes me really nervous about this is that that gap opened up when this happened when the Federal Reserve which you see here in its balance sheet in blue in March 2020 expanded that balance sheet by $3 trillion in three months and then after it was done to add $120 billion per month up until about this time last year which was to my mind amazing at this time last year it was clear to everybody who was looking at the data that we had an inflation problem and yet 12 months ago the Fed had not yet raised rates and it was still printing money which is crazy but that's what they were doing and so now the Federal Reserve is doing the opposite and they're not buying it back so we're starting to see a tremendous contraction in the Fed's balance sheet a tremendous contraction in the money supply and so one of the big questions is how much longer is the rate tightening cycle going to last and a lot of that depends on what happens to inflation and what happens to the employment market so the good news on inflation is we do seem to be past the peak of inflation and that's what we're looking for is however the employment market remains very, very tight if you look at the Eurozone unemployment is below by over half a percent where it was at the end of 2019 in the U.S. as I'm sure you saw two weeks ago today we printed a 3.4 percent unemployment rate that was the lowest since 1969 on the lowest in 54 years you have to go back I think what's crazier about this is that employers in the United States are looking to hire 11 million new workers they have 11 million job listings I went to Chicago a few weeks ago I walked by a five guys burger they're hiring people for $17 and 85 cents an hour you walk by almost any restaurant in the United States as well as a lot of hotels who are desperate for workers and are not finding them so wages are going up as wages go up that could be potentially very, very inflationary but there's something also really important in the inflation data we just got the inflation data earlier this week and it was sort of a small upside surprise but it was very, very upsetting to the market so what was particularly upsetting about this number for the markets I think was one component but it's the biggest and most important component of inflation which is the cost of home owner the cost of renting a home home rentals account for 34.4% of the CPI index that's more than a third of the index and rental costs have been rising by 7.8% year on year now in the United States the cost of renting a home typically follows the cost of buying a home with a lag of about 21 months on average so the cost of buying a home was increasing at its fastest point last May so if you take last May and you add 21 more months we might not see the peak of rental inflation until February 2024 give or take give or take say six months but the peak in rental inflation might not come until late this year or sometime next year and that's 34% of inflation so think about this if it's 34% of inflation and it's rising say at just 8% per year so say it doesn't get any worse it stays at 8% increase per year that implies 2.3% inflation before you've looked at any other aspect the problem here is if the rest of the CPI goes up at say 2% per year that implies 4% inflation that's way above where the bond market thinks it's going to be the bond market thinks we're going to have 2% or 3% inflation not 4% so if inflation stays at 4% bond yields could go higher that could put downward pressure on the equity market which as we've seen is very highly valued and potentially very fragile in the current environment so why have rentals been going up for two reasons first mortgage rates have been soaring they were 3% up until about a year ago you could get by a 30 year fixed rate mortgage in the United States was 3% now that same mortgage is almost 7% so it's more than doubled so this takes a lot of people who would have liked to have bought homes and forced them into the rental market the other problem is that vacancy rates are extremely low some people may be worried about a repeat of 2008 I'm not worried about a repeat of the global financial crisis we're going to have maybe a different crisis it's not going to look like the global financial crisis before the global financial crisis there was huge amounts of vacancy 10% of apartments in the United States were vacant today that number is around 5.8% it's the lowest it's been since the early 1980s in terms of home owner vacancy rates those are down to 0.8% the lowest we've ever seen since the government began collecting data in the early 1960s so we're not going to have a repeat of subprime we're going to have something very very different and so I think one of the questions is so what part of the equity market is going to be the winner well over the last decade since the huge bull market began in March 2009 the really big winner has been the Nasdaq tech dominated has done really really well the S&P has done fine the Russell 2000 has done okay the Russell 2000 is an index of small cap stocks it's been a bit of an under performer but the Nasdaq has done well for one reason and that's that it is dominated by IT and technology companies it also has a lot of big healthcare companies and big consumer discretionary companies for example Tesla is categorized as consumer discretionary I think the problem though for investors who've become enamored with the Nasdaq is that we have seen an almost perfect sector reversal between what happened in the first two years of this decade in 2020 and 2021 versus 2022 basically every sector that did really well back in the first two years of this decade did really badly last year in every sector that did really poorly at the beginning of this decade suddenly started to do very well so we've seen these kinds of sector reversals happen many times so they typically happen once a decade in a really big way for example the winners of the 1990s were tech stocks they were the big losers of the next decade from 2000 to 2009 the big winners from 2000 to 2009 were things like consumer staples health, materials, utility and energy stocks they were the big losers during the 2018s so I think we're heading for a major sector reversal and that has a lot of implications for how the different equity indices that trade on our market could behave so for example the S&P 500 and the Russell 2000 have had very similar performance since the Russell index began in 1979 in fact if you look at a long-term trade it looks like they do the same thing but if you take the ratio of them you see something very different you see very strong periods in which the Russell 2000 goes up versus the S&P and very strong periods in which it goes down and those periods often last maybe half a decade or more but the key pattern to look for here so during the last great inflation small cap stocks back in the late 70s and early 80s way outperformed large caps and the same thing happened during the recession in 1990 and 91 the same thing happened during the tech wreck in the early 2000s and during the global financial crisis small cap stocks prospered why because they have less debt and they're more nimble and they can move themselves and reposition themselves faster than big companies can so if we go through a period of economic turbulence perhaps another recession next year which looks increasingly likely small caps could be the big outperformers I would just mention very briefly there are times when large caps outperform but they tend to outperform in the late stages of economic expansion like during the great expansion in the 1980s the expansion in the 1990s and the second half of the expansion during the 2018s that's the time to own large cap stocks but it could be very, very risky now small cap stocks may be the big bargain here in the market there's one last slide for you before I turn everything over to David this is the Russell 2000 versus the Nasdaq the Nasdaq had a tremendous bubble in the late 1990s where it just massively outperformed small caps in the early 2000s and you divide it by the Nasdaq 100 small caps just plummeted in terms of large in terms of big tech companies and the Nasdaq 100 but then when the tech bubble popped in the early 2000s everything went very strongly in reverse and small caps had a huge, huge outperformance well small caps have been have been underperforming very strongly ever since about 2009 as we saw if a lot of these very highly valued tech stocks might respond poorly to a highly inflationary environment in which interest rates go up but a lot of smaller companies that people don't pay any attention to that people have completely overlooked and ignored might be more nimble and fast acting about adjusting to a new environment so I'm going to stop sharing my slide deck for a second I'm going to let David put up his I'm going to turn things over to him but I could only screen him and if I could screen him when he is out I think that is a point it's not like we had any it's going哪裡 at the extreme end think of any questions you might have then you can ask them to both of us once David's presentation is over all right so Dave over to you Eric can you see my string presentation, it's an enormous amount of information and it provides a very nice segue into the next portion where we're going to look very specifically at some equity index futures products available at CME to perhaps take advantage of some of the opportunities that Eric has been suggesting in his economic presentation. I will begin by also reminding people that what we're doing today is meant to be educational and informative and in no way should be construed as investment advice nor are we making any trading recommendations. You're going to see examples of potential trading strategies in the next few minutes but they should not be considered as investment advice nor recommendations to trade. Eric mentioned several of the major US stock market benchmark indices and we have futures contracts that are based on these indices at CME Group. Our leading index products, US dollar index products include futures contracts on the S&P 500 which is a large capitalization weighted index, the NASDAQ 100 which is also a large cap index, cap weighted and then the Russell 2000 which has already been alluded to as being a small cap index and then the granddaddy of them all is the Dow Jones industrial average. At CME Group, we began listing equity index products in 1982 just as the US was coming out of its inflation shock rate hikes and going into a period of economic growth with the listing of the S&P 500 and over the course of lifespan we've added additional index products to that suite. Currently of these four major US dollar indices, we offer them in two sizes, the standard versions that have fixed multipliers of between $5 and $50 and then we also have what we refer to as a micro suite of contracts with futures contract multipliers a tenth the size of the standard contract. So the purpose of this is to expand our marketplace to market participants who may have felt unable to participate in our markets because of the sizing of the standard E-mini contracts so the micro contracts offer an alternative to the same index priced futures contract but in a smaller version. What we're going to be looking at are basically contracts that trade against similar indices and are settled in similar terms on a daily basis. Our major indexes in the equity suite settled to a volume weighted average price that's calculated at the close of the New York stock markets 3 p.m. cargo time. In the last 30 seconds of trade that volume weighted average in the futures contract results in the settlement value of the futures contracts. At expiration all of these are what are known as cash or financially settled futures contracts. They settle to a spot index level calculated by the actual index provider so on final last trading day which is the third Friday of a quarterly contract month the S&P will settle to a special opening quotation calculated by the S&P company the NASDAQ will settle to its special opening quotation calculated by the NASDAQ and the Russell appropriately. They're settling to that spot index value which means that the futures price and the spot index on that last day of trading settle to the same value that's the mechanism that imposes the pricing integrity on the futures contract. If the futures contract were ever to get widely out of proportion to the pricing of the actual spot index there are plenty of Delta 1 desks and other proprietary trading firms that would simply buy what's cheap and sell what's rich in an arbitrage spread and force it either back into alignment or carry it all the way to expiration knowing that the two prices will converge at expiration so because of that the market can trust and and feels great confidence using the equity index futures for many purposes in terms of risk management but also for risk creation and we're going to look at what that means in a few minutes but you can see the growth in the activity in CME's equity index products particularly last year with the increase in trading volatility. If you look at this chart you'll see the light blue portions of the column representing futures volume the darker blue tips at the top like little match heads representing the proportion of volume done in options and if you look at this graphic from left to right you'll see options as a percentage of the total increasing with each year moving from left to right that's because options have become not just at CME but worldwide a much more actively used tool in terms of both risk management and trading. The green line shows a very important figure which is what is known as open interest and open interest represents positions that are open in a futures contract that have yet to be offset now because it's a cash settled contract anyone wishing to remain exposed to the futures contract as it approaches expiration simply rolls their position forward into the next quarterly contract so usually about five to seven trading days prior to that third Friday of a quarterly expiration the volume and the open interest will roll into the next quarterly contract so as we approach the middle of March which is currently the front month in equity index contracts you'll begin to see that by that before that third Friday almost 90 to 95 percent of the open interest will roll into the June contract to maintain those open positions so in addition to the volume the size of the open interest also denotes potential energy for future transactions and this also gives our market participants confidence to use the futures product because they know that they can not only get in but more importantly they can get out or roll forward so the idea of the high level of correlation between the futures product and its underlying benchmark index value has led to what is known as efficient beta to the benchmarks and beta just means that the correlation is very high in the futures contracts provide that beta in many cases in a lower capital or more capital efficient product than a cash related product it allows our end users who were involved in both markets to be able to use the futures contract and free up cash for other purposes like just regular business activities it allows them to move in and out of the market when they need to seamlessly and efficiently in a very fast and efficient manner and in many cases it removes some of the human trading elements by being able to have a full exposure to an index without day trading particular shares to bring the portfolio up to its balance but another key important aspect to futures versus either a cash basket of securities or even other index products like mutual funds and ETFs is the very efficient means by which you can short a futures contract selling a futures contract or shorting a futures contract is the same as going long it requires initial margins and maintenance margin but in both cases along in a short position don't require full notional payment that means that selling a futures position or are going short a futures contract is much much more efficient than shorting an ETF or even shorting an outright stock position because you don't have to borrow the security to short it borrowing a security to shorting it in the cash market results in lending fee adding an additional layer of expense to a short position this means that futures contracts can be used as a short position against a cash position against any other type of index type product but they can also be used against a long futures position and we're going to take a look at what that means in practical terms in just a few minutes. Eric has done a wonderful job of setting us up for the impact of interest rates and and how they affect the valuation of individual equities and then by extension what that might mean to equity indexes which are nothing more than composites of individual equity contributing shares so if we look at the performance just in the last 12 months from February of 2022 to the current period or current times we can see our three major indices the S&P 500 here represented by its ticker symbol SPX the NASDAQ 100 NDX and the Russell 2000 RTY show high levels of correlation in terms of their performance over the last 12 months but with some variation you'll notice the S&P being down 6.1 percent the tech heavy NASDAQ 100 down 12 percent in the same period and then the Russell 2000 small cap index down only 4 percent so while they've been in the same direction and are relatively highly correlated they're not perfectly correlated and this has to do to some degree to the influence of interest rates and interest rate expense in the calculation of the value of the corresponding index itself and it boils down to some of the things that Eric has already mentioned which is the constituents that make up the index itself when we look at the S&P 500 which is by far and away the most widely used benchmark for large institutional investors in U.S. dollars equity markets you can see that as of the end of January the S&P people in the calculation of the S&P index include in this largest constituent member the information technology sector at 26 and a half percent at the beginning of 2022 this number was closer to 27 or 28 percent of the index valuation 40 years ago you would have seen energy probably populated at the same type of equivalency so things change the index change but at least in in modern terms or in the last two years info tech has been the largest component of the S&P 500 but only between say 25 to 30 percent of the broad market index if we look at the NASDAQ 100 which is a large cap stock index you can see that technology as a sector represents over half of its index valuation and it's followed by telecoms which are also a sector that's influenced by rising interest rates but technology because of its consideration and growth companies or as a growth company are widely impacted in terms of their valuation by forward or the slope and level of forward interest rates so the tech heavy NASDAQ 100 index has been more dramatically impacted negatively impacted by rising rates in the last 12 months if we consider the Russell 2000 index you can see it's also widely diversified but in small cap companies and because most of the technology companies tend to be larger in capitalization in terms of their inclusion into these indexes telecom and technology are smaller in the in the Russell 2000 index it's dominated by industrials and financials and healthcare companies but again smaller smaller cap companies and a smaller exposure to a more interest rate sensitive sector like infotech so that if we consider the NASDAQ 100 futures contracts as they've performed in the last 12 months relative to rising rates here represented by a generic two-year treasury yield you can see the two year has gone from roughly one and a half percent last February to above four and a half percent currently in that same period of time up until about the turn of the year the NASDAQ 100 trended lower and as was represented in an earlier slide down 12 percent over this period of time a little bit of a hook higher in the last couple of weeks owing to the effect that the Fed is slowing down its rate of rate increases and also the market beginning to anticipate the Fed stopping its rate hikes and in fact as alluded to earlier potentially pricing in rate decreases in the latter half of this year early part of the next year so how might this be played out well certainly users of the futures market can simply buy or sell the index futures themselves and we have an expression at CME where the choice of the index matters and you can see depending on your point of view about the index or about how it might be impacted by rates might affect your choice of index for a long or short market strategy but there's another way to potentially trade the futures contracts and what I refer to as relative value strategies this would be analogous to what we would call long short strategies if you're if you're a hedge fund investor or you're familiar with the way hedge funds position long and short positions buying what they perceive to be relatively cheap and selling what they perceive to be relatively expensive on a relatively neutral basis it might be analogous to what you might call pairs trading in stock trading where you buy one shares of one company and short sell shares of another taking out the relative value difference between two highly correlated products we call these things spreads in the futures world and certainly in the equity index space you're able to do what are known as equity index spreads and all it is is simultaneously buying and selling two of these index futures on a spread basis or as a spread trade very common and effective way to capture what you might perceive as to be the relative value between these indexed products and because the index futures contracts are highly correlated themselves there could be lower market risk and therefore lower outright or a net margin requirements in a spread trade versus an outright market position let's consider a couple of examples and we're going to go back to an example that was alluded to a little bit earlier if we consider the Russell 2000 small cap index as a spread to the NASDAQ 100 index in this case on a two to one basis because of their different valuations in terms of their notional value of futures contracts and look at that way that spread performed within a rising interest rate environment here represented by the yield on the two-year treasury you can see that through most of 2022 a two to one ratio spread small cap to large cap or Russell 2000 to the NASDAQ 100 actually performed very very well the spread tails off here at the beginning of the year as again that the market's perception that the Fed may be slowing down rates are potentially stopping and easing late this year early next year caused the spread to back up just a little bit how did it perform over the course of the last 12 months well the NASDAQ 100 the tech heavy NASDAQ has previously reported down 12 percent where the Russell was only down about four how that worked out from a P&L standpoint on a two to one weighted spread a net gain of twenty six thousand dollars owing in large part to the gain made on the short position on the NASDAQ this is again one of the benefits of using a futures contract that the ability to sell them short is as seamless as going long and then if you look down in the bottom because the spreads represent lower market risk to the clearing house clearing rewards this type of a position with a 70 margin credit so if you look at the individual costs of initial margins on these positions and deduct from it a 70 credit the net margin is significantly lower than the two legs by themselves meaning that the return on the trade or return on the capital use to create this trade is significantly higher this is a very attractive feature for both institutional and commercial uses of our markets but could also be extended to individual retail traders using the micro contracts because the same phenomena that's being used here in a spread transaction with lower net margin would be affected in micro contracts as well. Another example using other index products available at CME Group include two futures contracts from the Russell 1000 suite of products Russell 1000 is a large cap index and it is also listed in two sub index 1000 products one being the Russell 1000 value index the other the Russell 1000 growth index if we compare or look at the last 12 months trading history of Russell value represented in the purple line versus Russell growth in the red line again high levels of price action correlation and then you've got the blue generic two-year yield showing the rise in interest rates over the same period of time both of these indexes are moving you know pretty much unchanged throughout the course of the year but maybe slightly lower if we consider looking at the Russell index composition you'll notice that the growth index takes into account the large cap companies of the Russell 1000 that have higher price to book ratios they're considered and are expected to be growth companies that's why they're called the growth index the Russell 1000 value includes those companies in the Russell 1000 that have lower price to book ratios and are considered lower growth values but have are priced at a lower price to book ratio they might represent a greater value trade so if one were looking to be more defensive in a equity falling environment value might perform outperform growth or if one feels that just from a straight valuation standpoint growth could be more negatively affected by higher interest rates than value one might choose to express that by being long value and short growth as a spread taking out that relative value difference between the two indices themselves and if we compare a one-to-one value to growth spread over the last 12 month rate rising environment you'll see that throughout most of 2022 value did indeed as a spread outperform growth over that period with that similar hook down into the new year resulting primarily from expectations of change in rate policy over the 12 month period value was only down less than 1% where growth was down almost 11 and a half resulting in a spread long value short growth of almost $15,000 on a one-to-one spread basis and once again because of the high level of correlation in the indexes themselves there is a margin credit relief allowed to the spread of 50% which means that instead of having to post $12,000 of margin on the outright legs you would have posted $6,000 boosting the return on capital as a futures spread as opposed to other ways to replicate that same risk in either mutual funds or ETFs or baskets of the individual indexes themselves so hopefully this gives you an example of how futures contracts can be used to replicate the risk of indexes themselves either outright long or short or might be considered as potential relative value trades as index spreads against them as either broad market indexes or more refined indexes like Russell value Russell growth that concludes my my formal remarks and I think what we'll do now is open up the webinar to questions from the audience I'm going to stop sharing my screen so we can potentially share individually as necessary welcome back Eric yes thank you that was great presentation David very interesting I really love the charts you had especially on the the sector weightings for the Russell the Nasdaq and the S&P 500 it really does show you how they can perform so differently from time to time in addition to the capitalization differences just what it composes them can be so vastly different well that's one of the things and the reasons why I love this this Tim McCourt tagline or choice of index matters and if you're tracking stock indices it's very important to understand the constituent makeup of the underlying index itself because they do perform differently in different market environments these were the sorts of things that you pulled out in your presentation but are also highlighted in the price performance of the various spreads that were demonstrated in in my part of the presentation so I don't I don't see any questions coming in are there any questions from any of the audience at this point yeah I just typed into the chat you know please type in any questions we're happy to answer you have both of us online for I guess up to I don't know half an hour more if you want you have plenty of time I know it's late for a lot of the participants here in Europe including for me it's already seven o'clock in the evening so I understand you know people might not be you know wanting to ask questions but let's see if we have any maybe give it another minute here another couple minutes looks like one just came in Eric oh yeah here we go yeah so what does it say what would you consider a good source of further educational material we can do a deep deep dive into the impact of each sector I don't even we have at CME on our website a link to our educational portal which is known as CME Institute and if you go to the website and you click on education it'll take you to institute and you can find potentially some information certainly information about sectors themselves but also there's an additional third party come commentary that might might be a source of intelligence on the sectors themselves I see a question here that I might take do you see a recovery in the tech industry so look the tech industry has been recovering very strongly so far this year so far this year we've seen huge huge rebound you know in the Nasdaq 100 you know a lot of big rallies and you know in Tesla Metas had a huge huge rally a lot of you know really strong performance in Microsoft particularly after they they came out with this chat GPT which you know seems to be getting a little bit more scrutiny now than it did at the very beginning like anything's possible there are both upside risks and downside risks a lot you know the big difference I think between the situation today in 2023 and the tech wreck back in 2001 and the tech wreck none of these tech companies had very strong earnings you know so they were all kind of very fragile in terms of their earnings picture you know and a lot of them didn't make any money at that time this time 22 years later these are hugely hugely profitable firms but even very profitable firms can become overvalued people can be willing to pay too much to hold their stock so like I think that it's possible the tech industry could see a recovery in terms of its prices and we have indeed seen that so far this year but you know during bear markets you very often see really strong countertrend rallies if you look back at the bear market from 2000 to 2002 there were huge rallies inside of that bear market during the global financial crisis there were occasionally periods of three four months where the stock market went up so I would treat these these rallies with a great deal of caution it's possible they could turn into lasting bull markets but it's also possible that they could founder and wind up going back down there's another question I'd like to know where I can learn more about the kind of valuation showed in the last two examples I don't know is that the last two examples that you gave David or the last two examples I gave I'm not sure do you know I don't in terms of the value the examples that that I gave are just simply based on the notional equivalent size of the futures contracts relative to each other the idea in the in the spread trade is to be as dollar-neutral to market exposure as possible so by having them weighted like two to one brussel to nasdaq is based on the notional equivalent values of the futures contract the value versus growth are basically a one-to-one trade anyway so and by the way that's also how the modern relief is set so that's my answer that question Eric are you still still a bit yeah I am I'm still available I actually turned my camera off for a really dumb reason so our lights here are on a timer and so I had to turn my camera off while I got up and ran around the room to turn the lights back on so I think I'm good now for another 15 minutes before I have to move again yeah I mean yeah I assume that's what they mean I think hopefully you answered Leona's question on that one I mean in terms of valuations I look at you know equity valuations in a lot of different ways you all kind of give the same thing you can look at price to book ratios price to earnings price to sales I look at equity market cap to GDP sometimes you know also versus our dividend futures the dividend futures are say mainly used by institutional investors but anybody I think can find them find them interesting so she responded Leona responded it was my question thanks but I'm wondering more if there was something more on the CME to learn about spread trading like you showed so Dave is there anything more on our website that she can go and take a look at there is through CME Institute if you go into the Institute's curriculum there will be specific archive material on spread trading there are some archive things on index spreads like we just covered in this webinar that go into maybe a little more detail about the actual construction of the trades so by all means check out CME Institute through the educational tab on on cmegroup.com yeah so cmegroup.com educational tab yeah I mean there should be a whole bunch of more information in there and you maybe maybe we can have Ticknell send out some of those links too that'd be yeah that's great do you see the question about the Fed can the Fed still engineer a soft landing oh yeah so the yeah that's a good question the Fed the Fed sometimes you know I I mean the Fed would like probably to engineer a soft landing the Fed would like all this just to magically go away you know the Fed would love you know inflation is to go right back to normal and unemployment could be low and everything would be sort of you know happy and and peaceful and the Fed has always had trouble engineering soft landings but sometimes they do manage to do it for example in the 1980s and we came out of that recession in the early 80s the recession was in 81 and 82 then in 83 and 84 we had the strongest economic growth I think we've ever seen in peacetime the economy had about a year and a half period where it was growing at an eight to nine percent per year which was too fast so the Fed raised rates and they managed to engineer a soft landing in the middle of the 1980s where in 85 and 86 the economy slowed way down but it kept growing there were sectors of the economy that were in recession it was a terrible time for farmers the auto manufacturers didn't do well the oil companies were doing badly because the price of oil crashed but overall the economy is doing well the service sector was doing great wall street was doing great you know and in the 1990s we also had the Fed successfully engineer a soft landing you know the Fed raised rates 300 basis points in 1994 the economy did slow down a lot in 95 and 96 but then it picked way back up and did really well in 97 98 99 so a soft landing is possible it's very very tricky to achieve and I think it's not going to be easy this time because the economy is so volatile right now because of all of the pandemic disruption which is you know in some ways the pandemic disruption is getting better like the supply chain problems have gone away but during the pandemic the federal government in the United States spent an additional six trillion dollars beyond its ordinary budget and that kicked off a massive wave of inflation and so now the Fed doesn't really know how to get this under control and the same thing by the way is happening in Europe to a smaller extent in Japan but it's happening in Latin America countries all over the world have sent interest rates to the moon we have very high levels of debt and leverage I would say a soft landing is still possible but it's going to be very very tricky for them to achieve I've got one question here about the metals markets we know the metals markets are going to be part of the subject of our next webinar so we didn't really talk a lot about commodities here but I think the next webinar we do on the same platform our tick mill is going to be purely focused on commodities so I'm going to give my best answer at here I think the transition metals are really interesting especially since Congress in the United States passed this new legislation last fall which appropriated 1.2 trillion dollars in infrastructure investment some portion of which was for green investments maybe at least two or three hundred billion dollars in green investments the price of copper really took off especially versus other commodities that it's normally somewhat linked to like oil and so you know I think that copper could do well out of the green transition you know I think that the United States is not the only country investing this China, Japan, the European Union countries are investing a lot and you know if we create recharging stations for hundreds of millions of new vehicles that's going to be a lot of demand for copper as we you know replace gas stoves somewhat controversially in the United States with electric stoves that's more new copper yeah and so there's going to be a lot of demand for copper and then of course lithium and cobalt are two of the key battery metals we have futures on both of these at CME Group they're relatively young futures but the cobalt future in particular is gaining a lot of volume and a lot of transaction that lithium future is starting to pick up I think soon we're going to be launching a this is a metal I always can never pronounce I always want to call it molly bednum that apparently it's molybdenum or something molly for short not to be confused with the party drug is also going to be launched on CME at some point I believe in the next few months so we're very very involved in states we're very interested in it and I will make sure in our next presentation we include all of these things is another question here can we get the presentation answer is yes I will PDF my version of the presentation my part of it I send it to tick mill and they can distribute it we're very happy to do that do you plan to include energy commodities not gas and oil in the next or future webinar and yes that's going to be the next webinar next web is going to be all commodities we're going to talk about net gas but talk oil like about metals in a very broad sense including copper cobalt lithium but also gold silver you know aluminum other metals and then we're going to do the agricultural goods as well so we're going to talk about corn wheat soybeans and related products so we're going to cover all those things in the next webinar that webinar is also going to talk a lot about what's going on in China economically which is a huge influence on all of the commodity markets as well as how the commodity markets relate to things like currencies and interest rates excellent all right do we have any other questions I'm not really seeing any other questions but we have a little extra time if anyone has any all right well I'm not seeing any other questions coming up but if there are other questions you can always email them to tick mill and they can pass them on to us and we'll do our best to to answer them otherwise we look very very much forward to seeing you for the next installment of this webinar which will be in March I forget the date I can't remember that you remember the date David tick mill will send out plenty of plenty of notices yeah they get plenty of plenty of publicity I'm sure for it that will focus on commodities we'll be doing a third one after that that I think we'll be focusing I don't really decide what's going to focus on but let us know what you want in the comments either this time or next time we'll focus it on whatever you guys want the next time but we haven't really talked much about currencies we could do more on rates plenty of markets to talk about and then also I will be doing an in-person appearance with tick mill at the shard here in London I also can't quite remember the date I'm tempted to say that 23rd of March but don't quote me on that it could be the wrong date so 23rd of March I don't think that could be right because that's a Saturday but it's going to be sometime in late March tick mill will also send you out things like that if you happen to be in London that would be great all right well it's really great being with you do you have anything David no thank you all for your time your interest in your patience we wish you the very best of luck and we'll see you at our next event in March Eric thank you as always it's a pleasure working with you and everyone have a nice weekend thanks you too