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Inside in Full: What do interest rates, crypto-winter, Trump, and insurance stock volatility have in common?

Sam Bankman-Fried. It is probable that many insurance industry observers pay less attention to the crypto markets and would not have heard of SBF until a few weeks ago...

Currently, the crypto world is in meltdown, with the SBF-led FTX exchange filing for bankruptcy and billions in investor funds unaccounted for.

But why are we talking about cryptocurrencies? Let’s take a step back. Based on their risk appetites and horizons, investors invest in a mix of equity and debt instruments.

On the equity side, investors might lean towards investing between growth or value stocks depending on the economic forecasts. For some investors with higher risk tolerance, cryptocurrencies are viewed as another investment class.

In theory, they should not all move in conjunction, but that’s a topic for another day.

Recent years have proven to be a unique moment in the broader markets with no real parallel. Multiple events seem to have overlapped, including unclear directions for interest rates and the economy, post-Covid recovery, the Ukraine war and its geopolitical considerations, Hurricane Ian, and now a reckoning for the crypto asset class.

To put the cherry on top, recent mid-term elections concluded with no clear mandate apart from former President Trump once again throwing his hat into the ring.

It wasn’t always like this. Value-focused sectors such as insurance and financials generally move in a narrow range. In fact, when we started in this industry, any insurance stock moving more than +/-3% was cause for alarm.

Unfortunately, 2022 has left those old ranges behind, with insurance stocks now moving double digits quite often, as we’ll discuss later in the note.

Beyond the overall volatility, sector and subsector trends have also played a part. For example, we show that value sectors typically lagged for much of 2021, and even 2022, before economic concerns led investors to flee in this direction.

Apart from the overarching economic climate, sub-sector insurance cycles have also opened a gap. For example, our data shows investors were disappointed in personal auto but felt better in reinsurance.

Beyond the discussion on volatility, trading volume, and insurance cycles, the election cycle adds its volatility to how these sectors perform. Depending on whom you talk to, you’ll hear them ruing, “Oh, the Trump years!” or “Oh, the Obama Years!” or even, “Oh, the Hoover years!”

Scratch the last one.

Our note will show what degree of correlation exists (does it?) depending on whether Republicans or Democrats control.

We discuss these points in detail below.

Firstly, value stocks come back into focus during an uncertain climate 

The tables below show year-over-year growth of trading volumes for value and growth subsectors. This analysis uses the S&P index definitions for different subsectors and includes all defined participants.

 

 We can see from the charts that the pandemic of 2020 led to a flight to value. Still, as growth rebounded on the prospect of an economic recovery for 2021, growth stock trading volumes fell by 8.8% on average, while value volumes declined by 16%.

However, with inflation becoming a more significant concern over 2022 and the federal reserve pursuing an aggressive rate action, value stocks were on investors' minds, and trading volumes jumped by 120% while growth volume increased 92%.

Secondly, a move toward insurance picked up recently over the third quarter reporting cycle 

For much of the year, the debate centered on the longevity of pricing cycles in commercial, personal, reinsurance, and brokerage space. The chart below shows the price movement of stocks grouped by sector.

 Above, we can see the brokerage segment was the most stable due to a slow drift down of strong organic growth numbers. On the other hand, reinsurance stocks rallied harder this quarter as the impact of Ian and a difficult market due to capital considerations added to pricing pressures.

Personal lines insurers were flattening but picked up due to a recently approved rate filing in California, likely signaling the easing away of regulatory pressure. Commercial insurers also did well as they played a balancing act between macro concerns and inflationary pressures, positively impacting the top line.

Though there have been several tough quarters, the price action indicates investors have been favoring the value stocks during these more volatile times.

The trading volume data shown below mirrors most of the price moves shown above.

 Reinsurance shows the most shocking growth, due to the conditions mentioned above, but the others show the recent shift as well.

Thirdly, the recently concluded mid-term adds to the confusion

Are Republicans better for the stock market or Democrats? The general perception seems to be that Republicans and their policies are preferred, since there is less interventionism and the overall economic climate improves as capitalism thrives, leading to better stock market returns.

Without picking sides, let's look at what data tells us. The table below shows S&P 500’s performance 12 months after the past few midterm elections (larger table in appendix). Trump’s tax cuts did propel the market, but Obama years had an anemic performance. However, Obama did inherit the broader economy in a different place.

Taking a step back, a simplistic correlation could lead to incorrect inferences, and the data below doesn’t support one party over the other.  

This uncertainty will likely add to additional pressure over the next two years since a split House and Senate will lead to difficulties in passing meaningful legislation. Hence we foresee this volatility to persist into 2023.

Appendix:

Below is our usual stock performance by sector update.

Personal lines carriers were up 1.2% from the start of the third-quarter earnings season (October 18) to November 14, and up 14.9% so far in 2022. Personal auto carriers continue to face worsening loss cost trends putting upward pressure on premium rates as loss ratios remain pressured. However, the stock prices reflect an anticipation of rate filings catching up.

InsurTechs were the worst performers, down 3.8% since the start of third-quarter earnings season, and down 55.7% year-to-date in 2022. InsurTech firms, especially those that went public in 2021, have been the biggest victims of the public market sell-off this year.

We discussed this in our previous note on InsurTech profitability discussing public InsurTech shareholders’ equity and the erosion of their capital base that forced companies to shift their business strategy. The next topic of focus is going to be a move towards embedded insurance, although that has yet to salvage depressed valuations.

Reinsurers were up 19.1% compared to the pre-earnings period and up 2.9% YTD. The first hurricane of 2022 came nearly three months into the season, but it left an indelible mark on reinsurers. But stock prices ticked up with the forward-looking sentiment of more pricing power to the reinsurers.

Even before Hurricane Ian, pricing and availability of reinsurance was a challenge. Resiliency in reinsurance share prices post-Ian suggests investors are seeing great potential in this sector.

Other sectors:

Large commercial insurers spiked 9.4% from the start of third-quarter earnings and are up 8.3% YTD. This relief rally was predicated on an anticipation that price declines will be at a measured pace and a social and loss cost inflation had not reared their heads in a material manner.

Insurance broker stocks had ticked up 5.3% as of Nov. 14, compared to the pre-earnings period, while they were down 2.1% YTD. Brokers generally do well compared to other P&C peers, but with the organic revenues on a downward trend and unclear guidance this was a slower moving sell off.

The charts below show stock performance by segment for November to date, as well as performances YTD, and the last one and three years.

The chart below shows stock performance for 2022 with specialty and reinsurers leading the group apart from personal lines leader, Progressive Corp. On the bottom of this lies a mix of insurtechs and Florida specialists.

  

 

Inside P&C provides unparalleled market intelligence on the entire US P&C market – from small commercial and personal lines right through to reinsurance and Bermuda. Redeem your complimentary 14-day trial for more premium content from Inside P&C.

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