Recessions are generally tough on financial stocks. Banks will experience bigger credit losses and real estate investment trusts (REITs) will see declining rent collections. If we see another market crash, the Federal Reserve's tools for managing it will be limited since interest rates are already at or near zero. So, if you still want to have some exposure to financial stocks in your investment portfolio, which ones are the best performers in a recession? The answer comes down to credit risk, and which stocks have the least amount.
ICE owns the venerable New York Stock Exchange
The Intercontinental Exchange (ICE 0.18%) is known primarily for owning the New York Stock Exchange. But Intercontinental Exchange (ICE) also owns some commodity exchanges and fixed-income operations. The exchange business is the classic example of a fee-based business that doesn't rely on taking credit risk. Exchanges facilitate trades, ensuring the buyer has the money and the seller has the securities. The exchange collects fees and sells the data to media outlets, brokers, and data terminals like those maintained by Bloomberg and Reuters.
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Financial stress benefits the exchanges
Recessions generally increase the amount of financial stress in the system, which often translates into higher trading volumes. Market crashes are almost by definition high-volume events. While a pre-recessionary market crash is not a certainty, such an event would actually benefit ICE, not hurt it.
A crash should increase demand for hedging products, especially credit derivatives and fixed-income indexes. Investors generally will trade where liquidity is highest because it reduces transaction costs. This means it will be difficult for a new entrant to create a new stock exchange that will unseat the New York Stock Exchange. The exchanges have true competitive moats that are tough to replicate.
The mortgage business represents future growth
Recently, the company has been increasing its presence in the mortgage business, buying the Mortgage Electronic Registry System (MERS), Simplifile, and most recently, Ellie Mae. While the price ICE paid for Ellie Mae did raise some eyebrows, the mortgage origination sector is experiencing record volumes due to the Fed's aggressive actions to support the economy.
The COVID-19 crisis has accelerated the move toward digital mortgages. MERS is the industry standard for managing title data, and Ellie Mae contains one of the most popular loan origination systems. ICE is developing a mortgage ecosystem that touches all parts of the origination process. These are all subscription and fee-based models, which means the company is taking very little credit risk.
As mortgage volumes swell, ICE will participate through its fee-based businesses. This represents an avenue for organic growth for the company.
ICE performed will during the first half of 2020
For the first half of 2020, ICE reported a 15% increase in net revenue and a 27% increase in earnings per share. Compared to the banks, which were forced to take huge COVID-19 related write-downs, ICE is up 8% year to date, easily outperforming the S&P Financial Select ETF (XLF 0.35%), which is down 19% over the same time period. The first half of 2020, with a record decline in GDP, represented a great test for ICE, which it obviously passed.
ICE trades at 22.7 times expected 2020 earnings per share and has a dividend yield of 1.2%. While ICE wouldn't necessarily be considered a value stock or a dividend stock, it is a stalwart that will take an investor through troubled economic waters.
