This column represents a clash of investment themes I've written about over the past several years. The first theme is defensive investing, in which I've discussed allocating capital into sectors in which consumer demand for the product is the least affected by economic activity. This is in keeping with investing in sectors that make and deliver the most basic products. I've written about grocers and food producers but I've also discussed the economy sector of lodging.
The second theme, germane to this column, has been avoiding the insurance sector. In 2011, I wrote about the traditional, negative effect a flat U.S. Treasury yield curve has on the earnings of insurance companies, and thus, the price of their stocks. For whatever reason, however, the flattening of the Treasury yield curve since the financial crisis of 2008 has had no substantially negative impact on the insurance sector, as I wrote in 2013.
One of the subcomponents to the insurance industry and its performance versus the yield curve, which has also not played out, is that traditionally lower long-end Treasury yields cause companies to increase the insurance premiums charged to policyholders; this causes the use of insurance to decrease. Even as this has been happening, policyholders have paid up, which has supported insurance stocks.
Still another subcomponent that has also not played out is that as insurance premiums increase, policyholders shift financial resources to mandatory insurance products and away from voluntary products. Mandatory products are generally in the property and casualty (P&C) space and include things like auto and home insurance. The voluntary products are typically in the life and health (L&H) space. The passage of the Affordable Care Act affected this, though, by making health insurance a mandatory product.
In any event, the traditional relationship insurance companies have with the Treasury yield curve appears to no longer apply, which brings me to insurance as a defensive investment. The industry now appears, due in part to regulatory changes, to be a required-consumption item, making it closer to the investment theme of investing in sectors least impacted by economic activity.
Within the insurance sector, the best opportunities for abiding by this investment philosophy are with the largest and highest-dividend-paying companies. The first of these is MetLife (MET). It is a large, global and diversified insurance company participating in both the P&C and L&H sectors, and, at 2.8%, it pays the highest dividend of all U.S.-based companies in the sector.
Although the sovereign yield curves in the company's primary global markets have all flattened substantially since the last U.S. recession officially ended in June 2009, the stock price has appreciated 72%. Trading around $50 today, it is still far below the $70 it had achieved in September 2007.
The second of the large diversified providers, although almost exclusively serving U.S. consumers, is Allstate (ALL), which has a dividend yield of 1.8%. Allstate has performed even better than MetLife since the last recession ended, with a 160% appreciation, which now almost has it back to its all-time peak in December 2006.
The next company that fits this philosophy is Progressive (PGR). Although it is only involved in the P&C space and concentrated in the U.S., it pays a dividend of 1.9%. Progressive is also up about 75% from the end of the last recession, and it's near its all-time peak from November 2005.
On the L&H side, the best play is Aetna (AET). It serves the U.S. market and pays a dividend of 1.1%. Although Aetna shares were down slightly today, its performance since the last U.S. recession ended has been the best, with the stock price more than tripling to about $76 from about $25.
As it now stands in the six years since Lehman Brothers failed, the last recession ended and global sovereign yield curves have steadily flattened, the traditional relationship between yield curves and the insurance industry appears to have fundamentally changed. I'm also very cautious about accepting the reasoning that "this time it is different," but in the case of insurance, this appears to be the case.
I'm still watching for signs that the traditional relationship will emerge again, especially since I'm still of the opinion that long-end U.S. Treasury yields have yet to reach a secular trough. But at this point, I'm more concerned about its negative effect on almost everything else in the S&P 500. If this shift in the relationship of insurance to bond yield curves is structural, however, it is also a bad omen for most other stocks, because insurance is a very low-multiplier financial and consumer product.