Bull Market Kills Exchanges But Not Your Profits

 |  Includes: AMTD, CBOE, CME, ETFC, ICE
by: Zachary Scheidt

Editor's note: Originally published on July 1, 2014

U.S. equities are moving steadily higher. We all know that…

It seems like every single day, you see a headline on the front of The Wall Street Journal, or hear some commentator on CNBC telling us that the market just hit a new record high, as if this was some sort of breaking news or important event.

What the commentators are not telling you is how damaging this bull market is to individual investors - on many different levels. We've already covered plenty of ground explaining how this market is extremely dangerous… How the stock advances have been built on financial engineering supported by the Fed… How equities are trading at extremely high valuations… And how the whole ball of wax could quickly melt if investors lose confidence and start bailing out.

Rather than re-hash our cautionary contrarian stance (I'm confident that by now you've taken measures to protect your portfolio), today I want to tell you about a group of stocks that is currently being hurt by the bull market.

That's right - the mere fact that most stocks are trading steadily higher is actually crushing this industry - and there is very little relief in sight. The good news for us as contrarian traders is that we have the option of profiting from the demise of this group. Let me explain…

The Problem with Today's Bull Market

Traders need volatility to make money. Just like a shopkeeper needs foot traffic (people moving in and out of his store) to sell his wares, a trader relies on investors moving into and out of the market in order to buy low and sell high.

Now, take a look at this monthly chart of the S&P 500. Notice how over the past two years we have seen essentially ZERO volatility - no healthy pullbacks, no back and forth, no NOTHING! Just a steady, boring move higher…

Image: S&P 500 Index - No volatility as U.S. stocks steadily trade higher...

Without volatility, it makes absolutely no sense to use an active trading approach. You'll just get chopped to pieces by commissions, spreads on entering and exiting stocks and other "slippage" costs. It's better to just stick with a few key stocks for the time being (and we all know how dangerous this approach is).

Now think for a minute about what this means for the companies that manage the exchanges where trades are executed. We're talking not only about stock market exchanges, but the exchanges which trade futures, options, currencies and so forth.

Companies like CBOE Holdings (NASDAQ:CBOE) which manages the old Chicago Board Options Exchange, or CME Group (NASDAQ:CME), owner of the Chicago Mercantile Exchange, are struggling in an era of low volatility and low transaction volume. There is just no reason for traders to be active in this market - and without activity, the exchanges are seeing their fees dwindle.

Retail brokers like E*Trade Financial (NASDAQ:ETFC) and TD Ameritrade Holding Corp (NYSE:AMTD) have it just as bad, with a couple of other challenges thrown in to boot!

First, these brokers are now fighting with the latest invention on Wall Street - "Robo-Advisors," which for a very small fee automatically generate "financial plans" for retirees who are sick of trading and just want to put their money in a basket of funds. As these "Robo-Advisors" gain popularity, conventional investors will be even less likely to trade their own accounts, resulting in fewer fees for online and discount brokers.

The second challenge is the coming bear market… Yes, we all know that this steady, plod-higher market can't last forever. But that's because we're contrarian investors and we understand the dynamics of how these markets work. Conventional investors are predominantly long-only. That means they have no tools that can be used to make money in bear markets. So whatever active traders are left will likely be crushed by the next bear market - leaving E*Trade and Ameritrade with even fewer customers.

Our Contrarian Solution

Fortunately for us, we don't need the market to gyrate back and forth to make money. As contrarian traders, we can be selective and patient with our trades.

Heading into the second half of the year, I've got my crosshairs trained stocks of exchanges and discount brokers as great Pullback Profiteer candidates. In fact, last week I set up a new bearish trade for IntercontinentalExchange (NYSE:ICE). This international company operates a number of exchanges around the world and has recently begun trying to decentralize its business by spinning off individual exchanges and revising its business structure.

If you want to know more about how these transactions are working, you can take a trial of my Pullback Profiteer service. Bottom line, things are NOT going as well as planned, which is no surprise, given the weakening volume and lack of volatility.

We're primed to make a gain on this trade, and I'm watching a handful of other exchanges very carefully to line up new trades as these stocks break down. As contrarian traders, we're set to make money while the more "conventional" investors wonder what happened to their favorite stock.

As we kick off the second half of this year, I hope you're prepared to make money on both sides of the market. I know I am! We've got some tremendous opportunities lining up and I'm looking forward to collecting our profits as the situations play out.

Disclosure: Author holds a position in ICE.