(PUB) Investing 2016

INTEREST RATES Will They or Won’t They?

WILL JANET YELLEN and her col- leagues at the Federal Reserve raise the fed funds rates on June 15? If you’re an investor, rather than a trader, it doesn’t really matter. A fed funds rate of 0.50% (currently) or 0.75% or even 1.00% remains extreme- ly low, allowing companies and con- sumers to borrow cheaply and spend freely. So rather than speculate whether the Fed will raise rates or not, let’s talk about how it impacts investors. One place where a higher fed funds rate would benefit investors is money market funds. You don’t need me to remind you, but for nearly two years, money market yields were stuck at 0.01%. But starting in June 2015, Prime Money Market ’s yield finally moved higher. As you can see in the chart below, the yields on Federal Money Market and Treasury Money Market followed suit over the next several months. At May’s end, yields ranged from 0.26%, to 0.45%, which, while nothing to get excited about, is a whole lot better than where they stood a year ago. And as the fed funds rate moves higher (whenever that is), I’d expect yields on money mar- ket funds to increase as well. I’m sure you noticed that money mar- ket fund yields started to rise ahead of the Fed’s first rate increase in December. Do the recently falling yields on Federal Money Market and Treasury Money Market suggest that money fund inves-

in 2004. The stock market rose for years before the credit crisis hit. By the end of the Great Recession, the Fed had cut rates down to the quick, where they’ve lingered since. It is not a foregone conclusion that small hikes in the fed funds rate will cause the stock market to tumble. Yes, there’s that old line so popular on Wall Street that you shouldn’t “fight the Fed.” But the Fed isn’t really put- ting up much of a fight itself. Investing entirely on any one fac- tor—whether it’s the fed funds rate, PE-ratios, GDP growth, unemploy- ment, or, well, you name it—is not a sound strategy. I would take the weakness in the markets, or sectors of the markets, as just another long-term buying opportunity. Health Care is still well off its highs. If you don’t have a full position in the fund (5% or so is good), I’d be a buyer. Don’t own any funds run by the PRIMECAP team, or only have a small position there? Back up the truck and do some buying. If you’re looking to make a quick hit, I can’t be of help. I don’t know where we go from here in the short term. But longer term, worries about the Fed, about whether higher rates help or hurt or any of the other myriad concerns trotted out daily by the media will be left in the dust and this will look like just another time when you could have bought lower while others were worried about near-term events outside of their control. n 2,500 Stocks Impacted by Much More Than Fed Funds Rate S&P 500 Fed. Funds

Tax-Exempt Money Fund Yields Join the Climb

0.5%

CA Tax-Exempt Money Market NJ Tax-Exempt Money Market NY Tax-Exempt Money Market OH Tax-Exempt Money Market PA Tax-Exempt Money Market

0.4%

0.3%

0.2%

0.1%

0.0%

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tors doubt the Fed will act in June? No. Those yields are in the hands of the mar- kets for ultra-short commercial paper. I wouldn’t worry over it. Yields on Vanguard’s tax-exempt money market funds have, as you might have expected, lagged their taxable sib- lings, but in mid-March, tax-sensitive investors started to see some yield on their money fund holdings. As yields on both taxable and tax-exempt money funds are now on the move, you need to once again pay attention to tax-equivalent yields. At first glance, Tax-Exempt Money Market ’s 0.30% yield looks paltry next to Prime Money Market’s 0.45%. But remember Tax-Exempt Money Market’s income is sheltered from taxes, so that 0.30% tax-free yield, is equivalent to a 0.46% taxable yield if you are in the 35% tax bracket. Calculations of tax- equivalent yields can be found on page 9 of every monthly newsletter issue. It’s pretty clear, then, that money fund investors should welcome a higher fed funds rate. But should stock inves- tors be worried that the Fed is putting on the brakes? Not yet. Take a look at the chart to the right, which plots the fed funds rate against the S&P 500 index. Note that when the Fed started raising rates in early 1994, this didn’t prevent stocks from rising, nor did cutting the fed funds rate in 2001 stem the S&P’s decline. Also look at the steady increase in the fed funds rate beginning

Money Fund Yields Up off the Bottom

0.5%

0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%

Treasury Money Market Federal Money Market Prime Money Market

0.4%

2,000

1,500

0.3%

1,000

0.2%

S&P 500 Index

Fed Funds Rate

500

0.1%

0

0.0%

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The Independent Adviser for Vanguard Investors • June 2016 • 15

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