Nothing reflects the view that the economy is improving and interest rates are headed higher quite like life insurance stocks. Beaten-up and left for dead during the worst phase of the financial crisis, some of the key Canadian names in the sector have continued to struggle during the rebound – with ongoing low interest rates weighing on earnings. But a shift is in the works: Big names in the sector have been showing surprising strength this year.
Manulife Financial Corp. has surged 30 per cent since mid-December, which is when the broader market began to rise in the latest leg of the bull market. And in one particularly good week earlier this month, the stock rose 17 per cent. Sun Life Financial Inc. has enjoyed a similar winning streak.
The gains come as investors reassess interest rates. The Federal Reserve has said a few times that it will hold its key interest rate at exceptionally low levels through 2014. However, improving economic data – highlighted by declining weekly jobless claims and upbeat monthly payrolls reports – have some observers wondering if the key rate could nudge higher well before that date. Canadian interest rates, which are also exceptionally low, would probably move higher, too.
Bond yields are already rising: The yield on the 10-year U.S. Treasury bond recently broke above 2.3 per cent for the first time since October.
That has investors moving early on insurance stocks, in anticipation of bigger earnings ahead. Earlier this month, Sun Life's new chief executive, Dean Connor, seemed to support this view: He said that the insurer's profits could rise to about $2-billion a year by 2015 if stock markets rise by about 8 per cent a year and interest rates gradually rise.
But Moody's Investors Service is taking a more cautious approach on the sector. On the upside, according to a report by analyst David Beattie, North American interest rates should begin to rise gradually later this year, "giving Canadian life insurers relief from spread compression and earnings pressure from spread-based businesses over time."
Indeed, earnings should become more predictable, ending an exceptionally volatile period that scared off many investors, as the economy continues to improve.
However, the downside risks are still pretty big: Europe's sovereign-debt crisis continues to hang over the global economy, and signs of a pickup in U.S. economic activity could thwart interest rate expectations. As Mr. Beattie explains, "a downside scenario of a protracted period of low interest rates triggered by the euro area debt crisis or macro-economic deterioration is increasingly possible."