U.S. insurance companies led by American International Group (AIG) , MetLife (MET) and Prudential Financial (PRU) , Travelers Companies (TRV) may have trouble reaching to new highs in the face of falling U.S. Treasury rates that are likely to curtail company profits.
The iShares Dow Jones US Insurance (IAK) fund, which contains all three stocks, was falling Monday, having pulled back over 1% from its 52-week high of $48.8, reached last Thursday. Falling Treasury rates are largely to blame as investors buy government bonds after aggressively selling them ahead of last week's Federal Reserve meeting.
Insurance companies and interest rates tend to share a strong positive correlation as insurer balance sheet's flourish amid an increase in rates. Insurers, which have steady cash flows, are compelled to hold safe debt to back their policies. As rates begin to rise, insurers are able to earn more money from bond investments, leading to share price gains
The chart below shows that the inverse relationship between the insurance ETF and iShares Barclays 20+ Year Treasury Bond (TLT) , a proxy for government interest rates, has held up well over the past month.
Treasury rates are pulling away from September highs as investors take profits on bond shorts that have paid off well in recent weeks. The Fed did not change its language as drastically as many had hoped in its September meeting, but participants in the Treasury market continued to push rates higher believing that improved economic data will spur the Fed to raise rates prior to next summer. After having pushed the 10-year yield up over 13% since late August, bond traders are now beginning to cover shorts, leading to a pullback in all U.S. rates.
The 10-year yield shows major overhead resistance at 2.65, while the 30-year yield sees resistance at 3.375, potentially suppressing rates over the coming weeks. As rates pull back, there will be the need for a fresh catalyst to propel rates of all term-structures above major resistance levels. Until that catalyst comes about, insurers too look stagnant below highs.
Avoid positioning too much long exposure in any of these insurers until a catalyst for higher rates presents itself, as a moderate pullback could be in the works while bond shorts continue to cover and take profits.
At the time of publication, the author held no positions in any of the stocks mentioned, although positions may change at any time.
This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.