“Part of the job of economics is weeding out errors. That is much harder than making them, but also more fun..” —Robert M. Solow, Nobel Laureate
By Mark Graham, chief of wealth advisory services, and Rex Macey, Chief Investment Officer, Wilmington Trust
Fear and volatility have returned to Wall Street. Stock prices have faltered this spring after rallying hard for a year. Wilmington Trust has been helping wealthy families manage their assets through the vicissitudes of the financial markets for more than a century. Our team of investment management professionals is confident in the longterm potential of the capital markets to meet
Mark Graham
investors’ long-term objectives.
The U.S. equity market was recently more than 10 percent below its latest peak. Newspapers quickly assigned simplistic explanations to this latest downturn, with “concerns over Europe” the most frequently cited reason. Debt problems in Europe do threaten economic growth, but there are other issues. Asia and Australia are trying to stave off inflation, and U.S. states and municipalities are contracting just as federal stimulus packages are expiring.
Negligible Inflation
U.S. core inflation declined significantly over the last couple of years, which is normal given the environment; high unemployment rates keep wages down; excess capacity suppresses the prices of finished goods; and the oversupply of housing drives down rents. Growth has returned, but its modest pace is keeping inflation low. On the other hand, inflationary government actions prevented growth from being even weaker, capacity utilization from being even more depressed, and the rate of inflation from falling even faster. Given these factors, we expect the Federal Reserve Board’s monetary policy to remain easy for an extended period.
“Rightsizing” of Housing Market
Housing prices have stabilized, but the level of serious delinquencies remains high. According to Bridgewater Associates, mortgage delinquencies are exceeding the pace at which they are being resolved, i.e., liquidated, brought current, or modified. This condition is partially due to the withdrawal of government support programs. Without continued intervention to slow the rate of home liquidations, we are concerned about a downward spiral: declining housing prices leading to even more negative equity, increasing the rate of defaults and losses and so on.
Fragile Economic Recovery
This recovery is fragile. Part of that fragility is the alternating periods of good and bad news. Just as the U.S. dollar has gone from outcast to king, views of the economy keep shifting. The nation’s official arbiter of the beginning and end dates of business cycles, the National Bureau of Economic Research, has been criticized for being too slow to call the recession over–so slow, in fact, that now we’re hearing predictions of a new recession.
We went from improving economic conditions last year to the current state of uncertainty. Despite this, we believe the economy continues to recover, if only slowly. Investors have been re-pricing financial assets to reflect changes in expected growth rates, which are best described—in the United States, at least—as anemic. In so doing, investors are doing the work that Dr. Solow ascribed to economists; they are weeding out errors.
