Morning Report / Has the COVID-19 ruling created an opportunity in the Insurance Sector? (LLC, VOC, QBE, SUN, IAG)

The ASX200 continues to rally on the back of a strong Banking Sector, yesterday we saw the local index advance +0.25% even after the Dow tumbled 345-points again illustrating the huge influence of the “Big Four” on our index. We’re less than 3-weeks into November and the markets already up 620-points / 10.5%, things might look stretched as the broad-based buying continues to diminish but at MM we’re happy to give the market the benefit of the doubt in an environment that can see NAB surge +17% in just one month.

The Australian economy appeared to help the market yesterday with last month’s employment data beating expectations although the $A and 10-year bond yields hardly moved implying it was certainly not a game changer to economists’ expectations for 2021. Basically the recovery story is already rolling through markets with the banks for example enjoying optimism around bad debts and housing prices hence the data was simply confirming what many believe will unfold next year, and it’s certainly not as bleak as many expected just a few months ago.

We like our statistics at MM as many subscribers will recall - this time last year the ASX had a enjoyed a strong rally from early October which topped out on the last day of November before correcting sharply in the first week of December prior to soaring to fresh all-time highs through December / January. For the traders out there, we can see a similar cycle unfolding this year, our key take outs:

1 MM remains bullish and believes stocks will be higher in 2/3-months’ time hence any selling is likely to be accompanied with a definitive follow up buying plan.

2 If we see a ~300-point correction in early December, similar to the one last month, we believe the risk / reward will be very enticing for the bulls looking for a Christmas rally i.e. always plan ahead.

MM remains bullish the ASX200 with stops under 6275.

ASX200 Index Chart

It was encouraging yesterday to see Lend Lease (LLC), one of our holdings in the MM Growth Portfolio rally to fresh post March highs. We like the companies move out of its struggling engineering business enabling management to focus on its traditional international and infrastructure areas, in our opinion great places to be at this stage of the economic cycle – MM is not looking to take profit on LLC at this stage.

MM remains bullish LLC.

Lend Lease (LLC) chart

Another stock performing well in our Growth Portfolio is Vocus (VOC) which is now testing its 18-month high. In the Weekend Report we mentioned a potential switch to Telstra (TLS) if the price differential stretched out towards ~$1.35, especially with the 5% fully franked dividend on offer, one of the main reasons why Australia’s largest Telco currently resides in the MM Income Portfolio. This action is still under consideration, but the price differential looks very capable of rallying above $1.50 hence at this stage we are in no hurry.

MM remains bullish VOC targeting ~10% more upside.

Vocus (VOC) Chart

Overseas Indices & markets

Overnight US stocks again were fairly quiet with the main indices all slightly higher into the close. The standout was the tech-based NASDAQ which is slowing regaining some strength and still feels ready to post fresh all-time highs in the coming weeks.

MM remains bullish US stocks into 2021.

US NASDAQ Index Chart

Has the COVID-19 ruling created an opportunity in the Insurance Sector?

Yesterday was tough day in the office for insurance stocks after the NSW Court of Appeal favoured policy holders with regard to business interruption insurance (BI) through COVID, most definitely not the outcome the industry was expecting. Insurance companies had been looking to include the virus as a “quarantinable disease” to decline claims – the announcement led to IAG shares going into suspense. It’s likely to be a large impact on the sector but nothing too scary as was illustrated by QBE and Suncorp only falling ~4% and 3% respectively. Earlier in the week Suncorp (SUN) had set aside an additional $125m for COVID claims suggesting this was their required buffer level.

The Insurance Sector has rallied strongly this month as like many other  pockets of the market it enjoyed a strong “recovery bid” with the obvious question being has this ruling created an opportunity to buy the dip or is it simply in the too hard basket. When we look at the picture of the sector below it remains ~30% below its pre-COVID levels putting it on the wrong side of the ledger from  a relative performance perspective but like the banks its been threatening to rise from the ashes as investors actively searched cheap stocks / sectors as the vaccine outlook improved dramatically.

At this stage on purely a sector level we prefer the banks before we look under the insurance hood but that doesn’t mean we won’t consider induvial plays into 2021 and beyond.

MM is neutral the Insurance Sector.

ASX200 Insurance Index Chart

Insurance stocks generally prefer a high interest rate environment because it allows them to hold received premiums in safe long dated bonds where the yield will help payout claims through the year, in simple terms the balance remaining is the revenue i.e. Premiums received + interest income – claims – costs = profit. Today’s almost zero interest rate environment is clearly a major headwind for the sector but it’s one we do feel has got as tough as its gets and the interest component of the above equation is likely to improve in the years ahead. MM’s medium-term outlook for bond yield suggests it’s time to be considering some insurance exposure for the future.

MM is bullish bond yields long term.

Australian 3-year Bond Yield Chart

Today I have looked at the 3 largest members of the sector who dominated the loser’s enclosure yesterday, it’s not been a great place to be invested in 2020 with all 3 down well over 20% year-to-date.

1 QBE Insurance (QBE) $10.00

A market serial underperformer for more than a decade QBE has become a potential recovery story in a market where investors are chasing many post COVID recovery plays. QBE has recently waved goodbye to its CEO an outcome that many shareholders might be cheering considering the stock’s performance. He departed with the combined operating ratio (COR) at a whopping 109.5%, an insurance loss of US$584M, an insurance margin of minus 10.6%, a net earned premium (NEP) decline of 3% in 1H20 and raised over US$1B in capital after taking investment risk which has proved to be excessive. This has occurred as premium rates have escalated and while It’s this premium rate increase which delivered hope it’s that same escalation that delivered the poor returns.

Overall, we believe that QBE is one stock that remains in the too hard basket until further notice.

MM is neutral QBE.

QBE Insurance (QBE) Chart

2 Suncorp (SUN) $9.43

Queensland based SUN has halved over the last few years with both its insurance and banking areas in the wrong place at the wrong time. Earlier in the month SUN released a trading update which was encouraging especially with its prudent BI provisioning which proved on point yesterday. Obviously there are many moving parts here with COVID having a significant impact across the board from loan deferrals to bad debt provisioning hence the improving economic back drop should help SUN but the markets clearly not yet convinced.

We are neutral for now, but I can envisage some spill over buying will flow through from the big banks the harder they run.

MM is neutral SUN.

Suncorp (SUN) Chart

3 Insurance Australia (IAG) $5.46

IAG went into suspense yesterday as Goldman started canvassing levels of interest for a capital raise, it feels like the BI announcement was the straw that broke the camel’s back on the cash front. No details had been released when I was typing this missive, but a discount feels inevitable. The appetite will be interesting with the risk / reward not too bad 5-6% lower, it’s probably not one for us but I can see the stock above $6 in the months ahead, although a test of $5 first wouldn’t surprise.

MM is neutral / bullish IAG.

Insurance Australia (IAG) Chart

Conclusion

No gems today, for anyone keen on the sector our preference is SUN, IAG and then QBE but MM cannot see ourselves venturing into insurance stocks short-term.

Have a great day!

James & the Market Matters Team

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