foxex: The Backlash

The Market Sum | Insight after the bell

By Caleb Silver, Editor in Chief

Wednesday's Headlines

1. Stocks fall as momentum fades, and regulators target banks and bonuses

Markets Close

Dow
25,673.46 -0.52%

S&P
2,771.45 -0.65%

Nasdaq
7,505.92 -0.93%

VIX
15.63 +6.04%

INV Anxiety Index
98.51 Low

US 10-Yr Yield
2.692 -1.10%

Stocks Slide on a Quiet News Day

U.S. markets faltered again on Wednesday as good news was hard to find. After promising progress on the U.S. China trade talks last week, the Trump administration and Chinese officials have gone quiet on the matter in recent days. While the talks have gone quiet, the Chinese stock market has been anything but. James has more on the Shanghai Composite's outperformance of the S&P 500, below.

The Federal Reserve released its 'beige book' survey of economic conditions in the 12 regions where it operates in the U.S. Think of it as report card or full body check up that measures everything from manufacturing activity to hiring, real estate activity and banking. While the report shows that most regions of the country are in relatively stable to decent financial health, it did reveal that the partial government shutdown had a bigger impact than anticipated. In fact, the word "shutdown", appeared 22 times in today's report. We read the report so you don't have to...but if you are interested, go for it.

Treasury to Ease Oversight over Non-Banks

In other government policy news, the Federal Stability Oversight Council, a division of the U.S. Treasury, proposed changes to limit the scrutiny of non-bank institutions that would loosen rules on lending. Non-bank institutions include entities like insurance companies and asset managers that don't provide retail banking. In the aftermath of the financial crisis, the Obama Administration cracked down on all financial institutions that lent money to consumers and businesses. At the same time, the Federal Reserve said it will change how it stress-tests banks to make sure they have ample liquidity in the case of a financial downturn or liquidity crisis. This easing of restrictions around lending and banking was to be expected under the Trump presidency.

GE's Slide Continues

We are not picking on one stock, but it's hard not to notice the sudden shift in investor sentiment towards the former blue chip. After rising 75% off its lows, GE has now fallen 15% in the past two days. This started with new CEO Larry Culp telling investors that free cash flow for its industrial unit would be negative in 2019. Today, an influential analyst downgraded the stock and said his $6 price target for GE was "too generous". The last 5 days for GE investors have been rough.

Facebook Promises a More Private Future

Facebook CEO and founder Mark Zuckerberg issued a 3,000 word memo today promising a more "privacy-focused" future for the social media platform. Facebook recently announced that it would combine its massive messaging platforms into a unified product for users, which would bring the messaging services of Instagram, Messenger and Whatsapp together. The original social network has been beset by criticisms over its privacy protections for users and allowing fake content into user feeds. The result has been a backlash from some users who have quit the platform, publishers who no longer use it as a social distribution channel, and advertisers who have stopped spending money to reach its 2.7 billion users.

Here's a key quote from Zuckerberg's memo today, acknowledging the skepticism many people have about its commitment to privacy.

"I understand that many people don't think Facebook can or would even want to build this kind of privacy-focused platform — because frankly we don't currently have a strong reputation for building privacy protective services, and we've historically focused on tools for more open sharing," Zuckerberg wrote. "But we've repeatedly shown that we can evolve to build the services that people really want, including in private messaging and stories."

Shares of Facebook have held up relatively well, despite the backlash. The stock is up nearly 6% in the past six months although in the past year it has fallen more than 6%.

While some users have deleted their accounts, Facebook is managing to grow its active users around the world, and generate revenue from them. Here's a chart from its most recent earnings report showing that active user growth around the world.

Bank Backlash

Speaking of backlash, there is new legislation being proposed by Democratic lawmakers that targets financial institutions and brokers right where it hurts.

The Wall Street Tax Act of 2019

Several Democratic members of the U.S. Congress introduced legislation to impose a transaction tax on Wall Street trading. It would be 0.1% per trade, which doesn't sound like much, but it would raise $777 billion over a decade, according to those lawmakers.

Read the bill here.

Perspective

The new Democratic leadership in the U.S. Congress has proposed an aggressive list of reforms that take square aim at the financial sector and executive compensation, as well as income inequality, more broadly. The financial services lobby in America is one of the most powerful special interest groups in the country. It represents the big banks, lenders and money managers that do not want to see legislation like this passed. The U.S. Senate, which is under Republican control, will also vote on this proposal. But expect this, like the other reforms, including one reigning in executive pay, to be big pillars for Democrats vying for the White House in 2020.

Chart of the Day: China Stocks Double U.S. Stock Returns

U.S. stocks had a third consecutive down day on Wednesday since the S&P 500 hit its year-to-date high at the major 2816 resistance level early in the week. Some have attributed this recent faltering in the U.S. market rally to uncertainty over the prospects of a successful U.S.-China trade deal. Meanwhile, Chinese equity markets have continued to soar with little hesitation. The benchmark Shanghai Composite (SSEC) index, a broad-based China equity index that covers all stocks traded on the Shanghai Stock Exchange, is up a whopping 24% year to date. This is no small feat for an entire major index, especially within the span of just over two months. In contrast, the S&P 500, the most common benchmark for U.S. stocks, is up "only" around 11%.

Exacerbating this discrepancy was a U.S. Commerce Department report released on Wednesday saying that the U.S. trade deficit with China hit its highest level ever in 2018. The overall U.S. deficit also hit a 10-year high, despite President Trump's highly protectionist trade stance. This report comes at a critical time, just as Trump and Chinese President Xi prepare to negotiate terms of a comprehensive trade deal that would prevent additional wide-sweeping tariffs from being imposed on both sides of the Pacific.

Reports also surfaced on Wednesday that Trump is pushing for closure on a U.S.-China trade agreement with the hopes that such a deal would boost equity markets and eventually help lead to his own re-election. As the U.S. trade deficit with China has been at record levels, China likely has significantly more to gain by securing a mutual trade agreement than the U.S. If this is indeed the case, China stocks could see an even bigger boost with any successful trade deal, potentially widening the "spread" even further between U.S. and Chinese stock markets.