Doing macroeconomic analysis is similar to the work a meteorologist does in trying to anticipate atmospheric trends and make projections of what the weather will be like in a certain place at a certain time. There are an infinite number of variables to take into consideration, but even with technology it's impossible to predict the timing of weather events, and sometimes the expectations are just plain wrong.
Even when they are wrong, though, there's empirical evidence as to what caused the prediction to be wrong; and that's the critical point at which the similarities between macroeconomic analysis and meteorology differ.
One of the trends I wrote about many years ago was the negative impact a flattening U.S. Treasury yield curve would have on the stocks of the insurance industry.
The oldest of those columns that's still in the archives is from almost exactly five years ago, "Insurance Sector Can't Survive a Flat Yield Curve."
I followed up that column the next month with the columns "Cancel Your Insurance" and "There Is No Insurance for Insurance," in which I discussed the negative impact of a flat yield curve on the sector and cautioned investors to avoid it.
Although the columns were well received by subscribers, the logic used in them, at that point in time, was largely known by investors and taken for granted. There was no great insight in them, just a cautionary reminder of what happens to insurance company operating margins when the spread between short rates and long rates shrinks.
For most of the past five years, though, until about a year ago, even as spreads widened and shrank throughout that time, the stocks of most of the U.S.-based insurance companies rallied steadily.
Aetna AET is up 185%; Allstate (ALL) 150%; Berkshire Hathaway (BRK.A) , American International Group (AIG) and Hartford Financial Services Group (HIG) all up about 90%; Lincoln National (LNC) and Progressive (PGR) 65%; and Prudential (PRU) about 30%.
The only outlier has been MetLife (MET) , but even it's positive by 5%.
By comparison, the returns of the European insurance companies has been dismal, with ING Groep (ING) , Allianz SE (AZSEY) , AXA SA (AXAHY) and Lloyds Banking Group (LYG) all posting five-year positive returns of between 2% and 6%. Still, though, they are positive.
Throughout the past five years, this has been an aggravation to me because I've not been able to figure out why investors have been willing to park assets in these companies knowing the ability of them to continue to perform would be negatively impacted by the flattening yield curve.
What appears to have occurred is that investors have assumed that the flattening of sovereign yield curves would not impact longer-term viability, and that during the interim they represented a safer place to park assets than in other economically sensitive sectors, especially since declining long-end yields caused the value of the securities already held to increase.
Within the past year, though, the implications of flattening yield curves on the fundamental structure of the insurance industry seem to have finally settled in with investors.
The European companies have been crushed by losses of between about 17% and 50%, and five of the nine U.S. companies are negative. The four with positive returns are all in the single digits.
If the trend toward lower long-end U.S. Treasury yields as a positive indication for housing activity continues, as I've been writing about recently, it should cause the stocks of the U.S. insurance companies to follow the lead of the European ones.
I offer this cautiously, though, because although investors appear to have become aware of the consequences of the flattening curve on insurance operations, and thus potential returns, I still cannot adequately appreciate why they did not begin to exhibit this understanding until about a year ago.
