Wells Fargo says bond market move could mean higher future returns

Today’s solid yields are not only providing income to investors, they may also translate into higher total returns in the future, according to Wells Fargo. The idea may feel counterintuitive to some investors, since bond yields and prices have an inverse relationship. When yields rise, bond prices fall. When yields fall, bond prices rise. Total return measures the income that a bond pays as well as any capital gain or loss from a change in price, up or down. These days, the 10-year Treasury yield is hovering around 4.55%, sharply above the 3.6% level that prevailed in September. Still, a Wells Fargo analysis of the total return of the Bloomberg U.S. Aggregate Bond Index since the late 1970s shows the starting, or current, yield was a very strong indicator of future returns of the index, said Brian Rehling, the bank’s head of global fixed income strategy. The strongest correlation to the initial yield level was near the five-year average return — so the higher the yield, the better the return over that five-year period, he noted. “This analysis implies that with the recent increase in yields, fixed-income investors may experience higher returns in the future than they have experienced in the recent past,” he wrote in a note last week. “Yield tells a story, and its relevance to performance is significant.” The iShares Core U.S. Aggregate Bond ETF , which tracks the U.S. investment grade bond market, currently has a 30-day SEC yield of 4.6%. AGG 1Y mountain iShares Core U.S. Aggregate Bond ETF over the past year In essence, with elevated rates, new buyers have a much higher income or yield coming in — and that provides a lot of cushion, he explained. “Even if rates go up a little bit, you can still make money and if rates go down you make money,” Rehling told CNBC. Of course, history isn’t necessarily indicative of future results and multiple factors should be considered when investors assess yield and returns, he added. Where to invest Rehling sees opportunity to pick up some yield now that the yield curve has steepened in the intermediate part of the curve — with maturities of five to seven years. He specifically likes investment-grade corporate bonds , despite spreads that are relatively tight. Spreads measure the difference in yield between Treasurys and other fixed income assets of the same maturity. Rehling also likes municipal bonds , particularly for those investors in higher tax brackets. The interest earned on municipal bonds is free from federal tax and may be exempt from state and local taxes if the investor resides in the same state as the issuer. As long as the economy is doing well, the muni market will also do well, he said. “We think the economy is in a good spot,” Rehling said, whiler acknowledging there may be better entry points at some point later this year. While rising yields may better position investors for future returns, owning bonds shouldn’t only focus on total return, Rehling said. “Fixed-income holdings can play an important role in many portfolios by providing an investor with diversification, lowering volatility, and providing liquidity,” he said.