With the end to rock-bottom interest rates and bond yields nowhere on the horizon yet, life insurance stocks are slumping accordingly.
The expectation that yields would break out of their stimulus-induced coma contributed to Canadian insurance stocks outperforming bank stocks in 2012 and 2013.
New economic fears have put an end to that run, bringing insurance sector valuations back into potential buying-opportunity range for the first time in several months.
"If you're a longer-term investor, you use this as an opportunity," said Norman Levine, managing director of Portfolio Management Corp.
Life insurance is one of the few sectors positively exposed to rising rates. Insurers derive part of their profit by reinvesting premiums received from policy holders, largely in bonds. When yields are low, profit suffers.
The long-anticipated sustained rise in rates looked as though it was in motion last year as the U.S. economy slowly improved and the U.S. Federal Reserve began to "taper" its bond-buying program.
The yield on U.S. 10-year Treasury bonds rose from 1.75 per cent at the start of the year to just above 3 per cent in December.
Insurance stocks traced those gains. Last year, Manulife Financial Corp. shares rose by 55 per cent, Great-West Lifeco Inc. by 35 per cent, Sun Life Financial Inc. by 42 per cent, and Industrial Alliance Insurance and Financial Services Inc. by 50 per cent.
Then the U.S. economic recovery proved its frailty once again, dragging with it bond yields as well as life insurance company share prices. The U.S. 10-year Treasury yield fell to an 11-month low of 2.4 per cent last week as revised GDP figures showed the U.S. economy contracted in the first quarter for the first time in three years, partly a result of a harsh winter. Canadian life insurance stocks have slumped off of their year-to-date highs by between 8 per cent and 12 per cent as a result.
"In a little over a year, the Canadian lifecos have gone from cheap to expensive and currently to a more reasonable level," Canaccord Genuity analyst Gabriel Dechaine said in a recent note.
The sector now trades at about 11 times forward earnings, which is in line both with the banks and historical average.
But there is more to insurance stocks than a play on relative valuations, Mr. Dechaine said. For instance, the sector has made much progress in improving the amount of capital it must hold.
"The capital ratios are in really good shape," said Paul Gardner, portfolio manager at Avenue Investment Management. "And from a balance sheet perspective, they're primed to either buy back stock or increase dividends."
Still, Mr. Gardner said he prefers bank stocks right now, partly because they can benefit from the ongoing low interest rate environment.
Mr. Levine, by contrast, prefers to play the eventual rise in yields through insurance stocks. He is concerned that high levels of household debt in Canada will negatively affect bank earnings. "The consumer is pretty tapped out in terms of mortgages and borrowing. The lifecos have much more potential going forward with rates going up," he said. Plus, the insurance sector is poised to increase dividends over the next six months to one year, Mr. Levine said.
Canaccord expects Manulife to increase its dividend in the first quarter of 2015, something the insurer hasn't done since slashing its payout in half amid the financial chaos five years ago.
Mr. Dechaine's preferred stocks in the sector are Manulife and Sun Life for their earnings growth, capital position, and valuations. He rates Industrial Alliance a "hold" over concerns about declining mutual fund sales, and Great-West Life a "sell" over ongoing profit disappointments at its Putnam Investments subsidiary.
That roughly reflects broader analyst sentiment. Of the 20 analysts covering Manulife, 17 rate it a "buy." Sun Life's coverage is evenly split between "buys" and "holds." And both Industrial Alliance and Great-West Life have a small minority of supporters, with each garnering just two "buy" ratings.