Economy

We have put to rest the first half of 2022, and we cannot say we’ll miss it.

The stock market suffered its worst first half since 1970, with the S&P 5000 falling nearly 20 percent since the start of the year. The broad index is down 21 percent from its high in early January and has been in bear market territory since early June.

There are some who will take comfort in the fact that the 1970 first quarter bear market was followed by a solid rebound. We are not so confident. The effective Fed Funds rate at that time was dropping from 9.25 percent in December of 1969 to 4.74 percent in December of 1970. In other words, the Fed was loosening the stance of monetary policy. Today, we have the opposite, with the Fed rapidly tightening to get inflation under control.

So, we are in an unusual situation in which the economy is very likely shrinking for a second consecutive quarter while the Fed is raising rates.

Household spending slowed in May to advance just 0.2 percent, the smallest monthly gain this year. Economists had forecast a bigger 0.5 percent gain. The previous month’s gain was revised down from 0.9 percent to 0.6 percent, indicating that the U.S. consumer spending was already weaker than previously thought.

Those figures do not account for inflation. Once you account for inflation, consumer spending actually fell 0.4 percent compared with a month ago. As we’ve pointed out a number of times, many of the prices of the economic data points that are published in nominal dollars have been largely concealing a real contraction. Americans are spending more but getting less.

Following the publication of the weak spending figures, economists across Wall Street began to scramble to bring down their estimates for Gross Domestic Product in the second quarter. S&P Global Market Intelligence, which had been expecting slight growth, now expects a 0.7 percent contraction. We expect we’ll be hearing from all the big banks in the days ahead. With growth projections already quite low, there are good odds that the revised forecasts will be negative.

The Atlanta Fed’s GDPNow model has the economy shrinking one percent in the first quarter, which ends today. Note, though, that the GDP Now tracker is not a forecast of inflation but an estimate based on publicly available data already released. It doesn’t try to guess at what the data yet to be released might tell us about the economy. As a result, this is a volatile series; so it could be yanked back up to positive territory as we get more data on the economy in the April through June period in the month of July.

The GDPNOW tracker is intended to show what recent data implies for current economic growth. It does not attempt to forecast growth based on unreleased data. So today’s negative reading could be supplanted by a positive reading in the future if incoming data is consistent with economic growth.

The question of whether we’re in a recession is everywhere. According to a very common rule-of-thumb, two consecutive quarters of economic contraction indicate that the economy is in a recession. We shrank 1.6 percent in the first quarter, so a further contraction in the second quarter would meet this definition.

Officially, however, we might not be in a recession. The official arbiters of when recessions begin and end is a committee formed by a private outfit called the National Bureau of Economic Research (NBER). The NBER says that “a recession involves a significant decline in economic activity that is spread across the economy and lasts more than a few months.” This is both more complex and more subjective than the two-quarter contraction rule. And it is a great deal more flexible. The last downturn in 2020 did not last more than a few months, but it was so deep and widely spread that the NBER declared it a recession.

To be sure, if we are already in a recession, it is a weird one. Unemployment is at the near-record low rate of 3.6 percent. Layoffs, as measured by new applications for unemployment benefits, are at levels we would normally associate with a growing economy. Continuing jobless claims are at levels not seen since the late 1960s. Job vacancies remain at historically high levels, and employers are still saying they cannot hire enough workers.

Does a strong labor market mean a recession is impossible? Not necessarily. Just as we experienced a jobless recovery, with very weak employment gains, in the aftermath of the Great Recession and the financial crisis, we could now be undergoing a unemployment-less recession, with very weak growth but not many layoffs. That probably will not last unless the downturn is short-lived. If growth stays negative for long enough, and consumer spending keeps declining, eventually jobs will likely suffer.

Meanwhile, the Biden administration continues to blame Putin for our economic woes.

During his press conference today at the NATO Summit in Madrid, President Joe Biden declared that “the reason why gas prices are up is because of Russia. Russia. Russia. Russia.” The incantation is unlikely to work because he forgot to spin around three-times and touch his nose while casting the spell.

The White House / Youtube

As we’ve pointed out previously, only 11 percent of Americans blame Putin for high prices, and repeating Russia over and over again will not change that. The displacement of Russian supply from the global market is a contributing factor to oil’s high price, but it hardly explains most of the increase.

In any case, reasonable people may wonder why a country that could once brag about energy independence now has a market for gasoline so fragile that it can be disrupted by a fight between Russia and Ukraine. It’s precisely this sort of the international turbulence that plentiful domestic fuel production should protect us from. So, it is the Biden administration and his allies in both government and the financial sector (we’re talking about you, ESG investors and fund managers) who have left us at the mercy of Vladimir Putin’s foreign policy.

Back when Jesse James prowled the land, the savings of the citizenry was constantly under threat by bandits looking to heist their money. These days, the money itself is stealing the savings of people in the form of high inflation and crashing financial markets.

Yesterday, we pointed out that the first half of the year was the worst for stocks since 1970. The S&P 500 dropped by around 20 percent, just shy of the 1970 bear market record of 21 percent. The Nasdaq Composite was down by 29.5 percent, the worst decline ever. The Dow Jones Industrial Average fell 15.3 percent, the worst since 1962.

We must confess, however, that things were even worse than we thought. Those declines are in nominal terms, meaning they do not take into account the massive inflation we’ve experienced in the first half of this year. Stocks were falling in dollars terms, but those dollars themselves were declining in value. As we’ve pointed out again and again, inflation introduces chaos into financial calculations that can often conceal deep points of economic stress.

Michael Hartnett, the chief investment strategist at Bank of America Securities, ran the inflation-adjusted numbers in a note for clients this morning. He found that this has been the worst start of the year for the S&P since 1872, the year Jesse James and Cole Younger led their gang to rob a bank in Columbia, Kentucky, and ended up shooting a teller who refused to open the vault.

At the time, the country was led by President Ulysses S. Grant, a military hero who was not exactly an ace at economic policy. The following year, the country fell into what was then known as the “Great Depression.” This severe downturn lasted from 1873 to 1879. At 65 months, it is still to this day the longest-lasting contraction identified by the National Bureau of Economic Research, outlasting the 43-month contraction of the Great Depression of the 1930s. Ten states, scores of railroads, hundreds of banks, and thousands of businesses went bankrupt during the 1870s Great Depression.

As bad as that sounds, Hartnett points out that 2022 is looking like the worst year for government bonds since 1865. Government bonds fell 15.4 percent in the first half of the year, even before adjusting for inflation. Year over year, they were down by around twice that. And that is before adjusting for inflation (which is hard to do when measuring bonds issued in a variety of currencies from all around the globe.)

This does not mean that there was no money to be made in the first half of the year. As everyone knows, oil and gas prices have exploded higher. Commodities overall had their best inflation-adjusted first half of the year since 1946, according to Hartnett. Oil rose 46 percent, natural gas 74 percent, and iron ore 28.2 percent.

Certainly, recent economic data will do little to reassure investors about the economy. Construction spending unexpectedly declined in May, the first drop in eight months. Strikingly, single home construction spending was flat for the month—before adjusting for inflation. In inflation adjusted terms, then, construction has rolled over and is declining rapidly. The Institute for Supply Management’s assessment of manufacturing showed growth continued, albeit at the slowest pace since May 2020, in June. But both employment and new orders fell into contraction territory.

The Federal Reserve Bank of Atlanta’s GDPNOW economy tracker had fallen into negative territory on Thursday. On Friday, it plunged even deeper to minus 2.1. Bank of America slashed its forecast for second quarter GDP to zero—before it got a look at construction and the ISM report.

Next week’s focus will be on the nonfarm employment report. All signs point to ongoing strength in the labor market, with the consensus for job growth at 250,000 and the unemployment rate at 3.6 percent. A big question mark is how long it will take for negative GDP growth, sharply rising interest rates, and high inflation to throw sand into the gears of the labor market.

Jeff Greene, who made his first fortune shorting subprime mortgages during the Great Recession, sees trouble ahead for real estate and no relief for crypto or tech stocks.

^{By Giacomo Tognini}

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D uring the last major recession from 2007 to 2009, a little-known entrepreneur named Jeff Greene made billions of dollars by buying credit default swaps on subprime mortgage-backed bonds as the housing bubble collapsed.

Now Greene, a Palm Beach-based real estate mogul with an estimated $5.1 billion fortune, thinks the economy is going through another bubble in assets ranging from crypto and SPACs to overvalued tech stocks and real estate. “We’ve been in an omnibubble, there’s no question about it,” Greene, 67, told Forbes in a phone call from his Hamptons estate, something he’s been saying for months now. “If you spend trillions and trillions of dollars in every advanced economy in the world and have coordinated fiscal and monetary stimulus, obviously you’re going to create bubbles and inflation.”

Asked when he thinks a recession will hit, Greene guessed it might come in the first or second quarter of 2023. “Next spring [we’ll] definitely be in a much slower economy,” he said. “If this recession really happens, you’ll have all kinds of people stopping their construction projects and laying people off and [you’ll] start to see unemployment creep up quickly.”

More than a decade ago, Greene made a fortune from the wreckage of the housing market and reinvested some of his profits into apartments and condominiums, eventually building a residential real estate empire concentrated in south Florida and Los Angeles. But despite skyrocketing prices for real estate across the country, Greene thinks the boom will soon turn to bust. “The real estate market is in a bubble,” he said. “We’re way overbuilt and you’re going to see a lot of people have problems with their real estate developments,” he posited, referring to residential real estate.

He also sees a parallel between the subprime mortgage crisis of 2007 and the booming stock market and crypto wave of 2021. “It’s like when I was doing the subprime short [betting that the value of subprime mortgages would fall] and I remember saying, ‘Who’s on the other side of this trade?’ These mortgage-backed securities had almost no possibility of being paid back,” he said.

“It’s the same thing with people saying, ‘Well I have to buy equities because I don’t want to make one percent [return with low interest rates] so I’m going to put my money in something that’s highly inflated,” Greene said. “And they bought crypto, SPAC shares, houses to flip, equities and private equity investments at unprecedented multiples of revenue with no prospect of earnings whatsoever.”

While he still invests in a range of stocks and private equity, he told Forbes he’s now more risk averse than he was a decade ago, with little debt on his real estate projects in Florida and New York, where he recently finished construction on a 30-story residential building in lower Manhattan. He’s also turned down several offers to sell his buildings for cash or invest in highly-valued private companies in early funding rounds. (He won’t say which particular companies have approached him.)

Unlike his successful bets against the housing market in the Great Recession, Greene isn’t shorting anything this time around. Asked what he would do if he was more open to taking risks, he outlined a potential strategy. “If I were more aggressive, because I saw this [bubble] happening, I would have sold more at the top. I would have built a war chest and been sitting here waiting for opportunities [to buy at lower values],” Greene said. “The kinds of deals that people were bringing to me to invest in some of these tech companies, I was getting calls [saying] ‘I can get you into this special round at a billion dollars, the company is doing $40 million in sales.’”

He found those offers to be overpriced: Greene thinks many of those tech companies are bound to run into difficulties as the stock market continues to drop and the economy enters a recession next year. “[I’m] thinking, ‘Who’s doing this?’” he said, referring to investing in startups at sky-high valuations.

“I have friends who are very smart people that were doing this and everybody thought they were going to be the next Zoom. A lot of these companies lose money and now they’re cutting expenses and trying to make it through this period,” he said. “You can be sure that there are companies that are going to be up against the wall. You’ll be able to get into some of these—what I call ‘science projects’ [because] they’re just sort of ideas that are unlikely to become huge—at very favorable terms. And people will make a lot of money, one of them will be the next Google or Amazon. In those spaces, there’ll be opportunities.”

Still there is no doubt that Greene is a beneficiary of the bubble. Greene, who’s lived in Palm Beach since 2009, pointed out the increasing exodus of billionaires and wealthy investors leaving northern states to relocate to south Florida, where property prices have soared since 2020. And it’s not just billionaires who are moving to the Sunshine State: rents in Miami rose nearly 26% on a year-on-year basis in the second quarter of 2022—higher than all major U.S. metro areas—and demand for apartments is near record levels, according to Marcus & Millichap.

“There’s just extraordinary migration to our area, which has put tremendous pressure on [real estate] values,” said Greene, who cited the recent announcement that billionaire Ken Griffin plans to move his hedge fund Citadel from Chicago to Miami as providing yet another boost to the local economy.

The influx of the superrich to Palm Beach has also increased enrollment at the Greene School, a nonprofit pre-K-through-high school in Palm Beach that Greene founded with his wife, Mei Sze, in 2016. There are now 150 students enrolled at the school, up from 123 in the 2019-2020 school year.

“The kinds of families who are moving into our town and putting their kids in our school, it’s like the all-star team,” he said, citing a pre-K class with parents including several Ivy League-educated hedge fund founders. “These are people that will create all kinds of jobs and businesses that are going to juice the Palm Beach county economy. I’m very bullish long-term on the economic growth and the value of my holdings there.”

Greene estimates that he owns “virtually all of the remaining high-rise development sites on the water” in Palm Beach, much of which he acquired after the housing market crash in 2009 when land values were cheap. But even if the property market in south Florida is still booming, Greene sees dark clouds ahead if, as he expects, the economy tips into a recession in early 2023—particularly for real estate investors who are highly leveraged.

Even among fellow billionaires, Greene has seen the impact of recession fears on their high-spending lifestyles. “I was at Hotel du Cap with a bunch of superrich people [two weeks ago], one of the most expensive hotels in the world in Antibes, France, and everybody’s saying ‘Oh my god, I’ve lost 30% of my net worth.’ But they’d already booked the hotel,” he said. “Those days are going to be over this winter. You’re going to start seeing people spending less money and the recession will kick in.”

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Households’ confidence in their region’s economy remains “down in the dumps” with Auckland confidence plummiting more than any other region in the June quarter, Westpac says.

Westpac acting chief economist Michael Gordon said the Westpac McDermott Miller regional economic confidence survey showed households across the country continued to battle cost-of-living increases, while falling housing prices also weighed on sentiment.

All regions were in pessimistic territory over the quarter with households’ economic confidence in their regional economy plummeting the most in Auckland, he said.

“Indeed, Aucklanders are at the forefront of both the cost-of-living surge and the correction in house prices,” Gordon said.

READ MORE: Regional economic confidence plunges on double punch of Omicron and cost-of-living increases Consumer confidence lowest since 2008 global financial crisis: Westpac survey

“From here, we expect that the ongoing rises in the cost of living and further falls in house prices will continue to weigh on regional economic confidence in most regions over coming quarters.”

Net confidence in Auckland fell from -6% to -37%, meaning it had both the lowest confidence in the June quarter, and the greatest decline in confidence since March.

Regional economic confidence reflects the difference between the percentage of survey respondents that expect economic conditions in their region to improve and those that expect prospects to worsen over the year.

Otago was the least pessimistic region and saw the biggest improvement for the quarter.

Its regional confidence increased from -19% in the first quarter to -2% in the second.

Westpac senior agri economist Nathan Penny said it was buoyed by the return of tourism.

Confidence improved from the March quarter to the June quarter in five out of 11 regions however, net confidence was in negative territory for every region.

While the direction of change was mixed over the last quarter, every region was now in pessimistic territory, he said.

Drought conditions hit household economic confidence in Southland and to a lesser degree the Waikato over the quarter, he said.

The survey was conducted over the first half of June, with a sample size of 1559.

Meanwhile, ASB’s regional economic scoreboard ranked Canterbury, Tasman and Nelson as the top three performing regional economies for the March quarter.

Canterbury had been helped by its resilient housing market, ASB said.

“While house prices are softening and construction activity are easing in the other main centres, Canterbury hasn’t experienced the same dip in prices or activity given affordability wasn’t quite as stretched to begin with.

“Still, with headwinds mounting and growth set to slow over the next twelve months, it’s going to be a challenging period for just about every region, even as strong commodity prices and the New Zealand border opening provide some key supports.”

Labour market data continued to stay strong with unemployment at a record low of 3.2% in the first quarter, while an annual wage increase of 3.1% represented the highest wage growth since the global financial crisis, ASB said.

“And we expect it to stay on the rise for most of 2022.”

Manufacturing activity slumped in June to a two-year low as new orders and employment contracted, the latest sign that the economy is weakening under the burden of high inflation, and tightening monetary policy.

The Institute for Supply Management’s index of manufacturing activity fell to 53 last month from 56.1 in May, according to data released Friday. The reading was weaker than the Econoday median forecast of 55.

Readings above 50 indicate ongoing expansion and readings lower indicate contraction. The June number indicates expansion has slowed and may be nearing a reversal.

While the manufacturing sector is only a small part of the overall U.S. economy it is seen as a bellwether. Declines in manufacturing often precipitate broader declines.