Commentary from John Ameriks, head of Vanguard Quantitative Equity Group


John Ameriks, Vanguard’s head of equity, provides insight on the implications of interest rate moves for stocks, bonds, and Fed policy.

TRANSCRIPT

Vanguard Perspectives®

Hi. I’m John Ameriks, and I oversee a team at Vanguard that has responsibility for the management of several of our active equity funds. We get questions these days on how investors should think about changing interest rates in this environment.

Why interest rate changes aren’t all bad (or good) news . . .

John Ameriks: Interest rate movements are a complex topic, and have a lot of different impacts. There’s good news and bad news.

For bond investors, obviously if you’re invested in a bond fund and rates are rising, in general you’re going to see poor results, at least up front. As interest rates rise, bond values will fall, and that means negative returns in the short term.

In the longer term, with higher interest rates, you’re receiving higher interest payments in your funds, so those results can be a little bit better going forward.

In terms of the equity market, interpreting how stocks and bonds interact with one another can be a little difficult. For as long as most people can remember now, since the early 1980s, as interest rates have come down, equity markets have tended to do really well. At this point, we’re in an environment where rates have been low for a long period of time, and trying to determine whether that relationship’s going to continue going forward is a little tricky.

Rates tend to reflect overall economic circumstances. In general, as interest rates are higher, it means the economy’s healthier, it means growth levels are higher and more robust, and things are going better. Hence, it means capital’s a little scarce, people are finding good uses for it. That tends to be very good news for equity market investors. It generally means that growth rates are good for stocks; firms are making a lot of profits. And a lot of times the monetary authorities are raising rates to try to make sure that firms and investors have a level head and are making reasonable trade-offs in terms of their decisions.

At some point, higher interest rates could also mean, though, that inflation is back and the Fed is worried about poor decisions that have been made in the past leading to too much growth. At that point in time, higher rates can really be a negative for equity market investors.

As a lot of us know, the Fed, in December, made the first decision to raise interest rates in many, many years. Many investors are trying to interpret what that means, especially at the same time that they’re seeing other central banks around the world head in the opposite direction. In fact, Japan very recently decided to take rates negative. It kind of makes for a two-speed world economy right now and is associated with a bit of the volatility that we’re seeing in the markets.

Important information

All investing is subject to risk, including the possible loss of the money you invest. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.

Investments in bonds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer’s ability to make payments.

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