Much has been said about Canadian life insurers after last week's rally that saw Industrial Alliance rise 18 per cent, Manulife jump 12 per cent, and Sun Life pop 11 per cent, even though the S&P/TSX Composite Index was flat. The reason? Surging long-term bond yields.
The question now: is it safe to buy in? Not exactly. Market sentiment for life insurers has been very weak, so the recent pops were largely the result of hope returning. Plus, long-term yields have since come off a little bit.
Deeper down, there are bigger issues to consider. "To be more positive on the lifecos, we would need to see: 1) more evidence that core earnings are growing, which is not occurring; and 2) much more meaningful rate increases than the 30- to 40-basis point increase that we have seen so far in 2012," RBC Dominion Securities Andre-Philippe Hardy explained in a new research note.
By his estimations, higher interest rates are needed for the insurers to simply meet their ROE targets of 10 to 12 per cent. That means the only way higher rates will really boost the insurers' fortunes is if the yields jump much higher. (Keep in mind that Manulife and Industrial Alliance are the most exposed to long-term rate fluctuations.)
"Investing in lifecos as 'a play on higher interest rates and equities' only makes sense for investors looking for annual equity market returns in excess of 8 per cent and annual interest rate increases in excess of 50 basis points," Mr. Hardy added.
For that reason, he still believes that investing in Canadian banks over Canadian lifecos is the better bet.