Who is going to pay for all of this? Well, judging by the market's Pavlovian response to renewed hopes of stimulus yesterday, it would appear the conventional wisdom favors "the gubmit". Yes, Uncle Sam's going to make everybody whole after the economic depredations caused by Covid-19 lockdowns. I disagree. I think the real bill is going to come due for companies that are designed and built to pay for things. Not so much the banks, which have other profit centers, including stock market-making, but the insurance companies.
There are casualties from low interest rates. Powell and his feckless band of Merry Men and Women at the Fed will never understand this. This really hit home as I was researching General Electric (GE) . My firm has a short position in GE via put options.
GE has a problem that will never go away in GE Capital. Specifically this week's news is of the company receiving a Wells Notice from the SEC over possible accounting fraud related to GE Capital's long-term care insurance policies. I tend to think people living longer is a good thing, but that's not the problem for GE, no matter how questionable their accounting practices. Any insurance policy is based on the reinvestment of premiums paid to offset what will eventually be a payout. It's coming, but if proper actuarial work is done to measure payout probability and its assets - the sum of premiums paid - are invested in high-yielding securities, then an insurance company can earn a real return on its capital employed.
But there are no high-yielding assets in the world of fixed-income anymore. Seriously. They do not exist in 2020 thanks to Powell's Fed, Lagarde's ECB, and a menagerie of other central bankers around the world. So it's very difficult for insurance companies to balance out their risks.
GE is obviously a "special" case, is it was mismanaged for 16 years by Jeff Immelt, who was incompetent enough to have a future at the Federal Reserve. Larry Culp has not done much better, but, again, we shouldn't let the company-specific problems obscure the structural problem here. Interest rates are too damn low. Either insurance companies --traditionally among the largest consumers of fixed-income paper -- are going to have to take much more risky positions in their investment portfolios (more stocks) or their own stocks will remain radioactive.
I think the latter happens. I want to be short insurers. In addition to my short on GE, there are two main insurance ETFs from the ETF giants. S&P's product is the SPDR Insurance EYF (KIE) and iShares offers (IAK) , its U.S Insurance ETF. They are both good shorts here.
Obviously there are thousands of different types of insurance and the publicly-traded companies have different exposures to the subsectors of the insurance industry. That's why ETFs make sense here.
The devastation to small businesses from Covid-19 lockdowns globally is something the likes of which modern finance has never seen. I just don't think market participants know how to process it, but veteran financial executives at insurance companies will know the answer: reserve, reserve, reserve. Increasing reserves decreases operating income, and I believe we are only at the beginning of a supercycle of economic pain for insurers. So, balance out your longs with a short in IAK or KIE, and protect yourself by betting against the protectors.
