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NEWS & INSIGHTS | THIRD QUARTER 2023
The Ryder Cup and the Yield Curve
October 2, 2023
By Mark Oelschlager, CFA
One of the great competitions in sports took place over the weekend. The Ryder Cup biennially pits the top golfers of Europe against the best from America. For many decades the US dominated the matches, but this changed in the 1980s and 1990s, and the Europeans have actually won more often than they have lost since then. This shift in competitive dynamics ushered in an era of greater intensity, scrutiny and pressure - and even some chippiness in the gentlemen’s game. Players say that the pressure they feel in the Ryder Cup is greater than in any major tournament, such as the Masters. Interestingly, some players have thrived in these competitions, while others who have sparkling resumes have struggled.
The competition alternates locations between the US and Europe, and “home-field advantage” has been incredibly important. In the last eight Ryder Cups contested on US soil, the US has won 5 and lost 3. Meanwhile, entering the weekend, the Euros had won each of the last six times that it was played overseas. That disparity of results based on location is striking, but what makes the results in Europe even more interesting is that in general the US was favored to win. Every two years, the US appears to have the superior team, with more players positioned near the top of the world rankings, and every time they play in Europe, they lose. The US team again this year was “supposed” to win the event in Europe, but again failed, making it seven losses in a row on foreign soil.
Every four years ahead of the matches in Europe, the “experts” provide explanations as to why history doesn’t matter and why the US will prevail, only to see Europe win again. This consistent failure to adjust expectations despite history reminds us of the dismissals of the predictive power of an inverted yield curve that we see every economic cycle. When long-term interest rates fall below short-term rates (inversion), it has been an incredibly accurate harbinger of economic recession. Yet each time the curve inverts, many commentators lay out the reasons that it is different this time. Sometimes these arguments sound sensible, but they tend to be trumped by larger factors that bring down the economy. In the summer, the consensus began calling for a “soft landing,” meaning that we would avoid recession. At some point the US will win the Ryder Cup on foreign soil, and at some point the yield curve will invert without being followed by recession, but it seems wiser to bet the other way.
September is historically the worst month on average for stocks, and 2023’s version lived up to its reputation, dragging the broader indices into negative territory for the quarter. The continued rise in Treasury yields and a spike in the price of oil provided a headwind. The rise in yields can be at least partially explained (especially on the short end of the curve) by the market finally starting to believe the Federal Reserve’s (Fed) vow to keep interest rates elevated. Many had been looking ahead to the Fed cutting rates, but given resilient inflation and the persistent strength of the labor market, the outlook for rates is now higher for longer.
Two-year yields are now above 5% - they were less than ¼% two years ago - and the 10-year Treasury has spiked to 4.6%, a 16-year high. Despite mortgage rates skyrocketing north of 7%, housing prices have held up surprisingly well. The vast majority of homeowners have low-rate mortgages locked in. If they were to move, they would have to take out a new mortgage at a much higher rate. Thus, for most Americans there is a disincentive to move, which keeps available inventory low, which keeps home prices high. Of course, for other loans that turn over more frequently, the bite is being felt – both by consumers and businesses. As an example, according to data from Cox Automotive, it takes the average American 42 weeks of income to pay off a new car loan at current prices, up from 33 weeks before the pandemic.
Higher interest rates are hurting the US Treasury as well, as it is forced to pay more money to service its debt. Here is an astounding/concerning statistic: about 1/3 of the US Treasury’s $33 trillion in outstanding debt matures in the next year and a half. This debt will have to be rolled over at much higher interest rates, which will force the government to have to borrow even more. We are likely to see the national debt spiral upwards in the coming years.
Speaking of Treasury debt, if you bought a US government 30-year bond in the Spring of 2020 and held it until today, you would have lost about half your money. US government bonds are considered safe – and they are in that if you hold the bond until it matures you are almost certain to be paid back – but the opportunity cost of being locked in at a 1% yield for 30 years when far higher yields are available is real, and what drives the value down. This is a great example of the importance of understanding what you own and the range of possible outcomes. Humans have a tendency to extrapolate the recent past far into the future, but history shows that conditions change and that it’s important to respect the possibility of that change occurring.
The Far East has experienced quite a bit of change recently. After trying for decades to rid itself of deflation, Japan has finally succeeded, and is now wrestling with how much to allow its interest rates to rise to contain its newly created inflation. Meanwhile China is dealing with various problems of its own. The property/housing bubble that has existed for many years appears to finally be popping. Evergrande, at one time the most valuable real estate company in the world, has filed for bankruptcy, as residential real estate prices fall. The Red Dragon’s export machine has slowed, as has foreign investment, as global corporations look to distance themselves from the increasingly confrontational and controversial positions of President Xi’s regime. Many companies have moved their production facilities from China to other Asian nations, like Vietnam. Apple is moving much of its manufacturing to India.
China is responding to its problems by applying various stimulative measures to the economy and exerting more control over its stock market. The Wall Street Journal detailed regulators’ actions, such as banning many companies’ biggest shareholders from selling and limiting sales of shares from controlling shareholders. Major investors were also “encouraged” to hold shares. Can you imagine the US government telling money managers when they can buy and sell? This feels like standing on the beach and trying to stop the tide but is consistent with the country’s history of treating the symptoms or shooting the messenger.
In the late 1980s there was all sorts of talk about Japan’s economic miracle and how they had discovered a better system. Their rapid economic growth and aggressive purchases of US properties created fear that they would overtake the US as the world’s economic leader. Some of the characteristics of Japan’s economy from that time included heavy governmental involvement, a real estate bubble, above-average economic growth, mercantilism, and a proclivity to steal intellectual property from the US. Sound familiar? Time will tell how China fares; it does have a large trade surplus, which allows it some flexibility and will likely prompt it to continue to try to prop up its economy.
Of course, the US has its own problems at the moment, like inflation, labor strikes and rolling budgetary crises. It will be interesting to see how much longer the US economy can weather this spike in interest rates, and how long stocks can maintain their appeal in the face of these higher rates.
Mark Oelschlager, CFA
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