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Top 5 Financial Stocks to Tap Higher Government Bond Yields

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Wall Street has been reeling under volatility in September after an impressive rally in the first eight months of this year. The spread of the Delta variant of coronavirus, slowing economic growth, higher inflationary pressure and the Fed's signal of a possible tapering of its quantitative easing program starting this year dented investors' confidence.

However, the fundamentals of the U.S. economy have stayed solid and the overall trend of the market remains encouraging. On Sep 27, the yield curve on U.S. government bonds stiffened primarily due to strong economic data and the Fed’s decision of tapering.

A hike in risk-free market interest rate will raise the cost of funds, which in turn will enable the financial companies to widen the spread between longer-term assets, such as loans, with shorter-term liabilities, thus boosting the sector’s profits margin. Consequently, the Financial Select Sector SPDR (XLF), one of the 11 broad sectors of the benchmark S&P 500 Index, has gained 1.4%.

U.S. Government Bond Yields Surge

On Sep 27, the yield on the benchmark 10-Year U.S. Treasury Note jumped to as high as 1.52% before settling at 1.482%. The yield was 1.459% at the end of the previous trading day on Sep 24. The yield reached its highest since Jun 30 and recorded its largest five-day gain since Mar 18. The yield is currently hovering above 1.5%.

The yield on the long-term 30-Year U.S. Treasury Note touched as high as 2.05%, the highest level in one month, before settling at 1.994%. The yield was 1.987% at the end of the previous trading day on Sep 24. The yield posted its largest three-day gain since Feb 16.

The yield on the short-term 2-Year U.S. Treasury Note ended at 0.28% compared with 0.274% at the end of Sep 24. The yield recorded the highest level since Apr 17, 2020 and a new 52-week high.

Strong Economic Data

On Sep 27, the Department of Commerce reported that the durable goods orders surged 1.8% in August beating the consensus estimate of 0.7%. July’s data was revised upward to a gain of 0.5% from a loss of 0.1% reported earlier.

Moreover, new orders for core capital goods (non-defense capital goods excluding aircraft) rose 0.5% in August. July ‘s data was revised upward to 0.3% from 0.1% reported earlier. Year over year, new orders for core capital goods jumped 16.4%. This metric is a closely watched proxy for business investment plan. Shipments of core capital goods rose 0.7% in August after rising 0.9% in July. This metric is used to calculate equipment spending in GDP measurement.

The above-mentioned data are very important at a time when market watchers are primarily concerned about consumer spending in view of the termination of the weekly unemployment benefit and the possibility that the central bank will gradually pull down the pandemic-induced monetary stimulus. Healthy business spending in the second half of 2021 should compensate for any material decline in consumer spending, if it happens at all.

Insurance Industry to Gain

A major part of the financial sector is the insurance industry, consisting of life insurers, property and casualty insurers, accident and health insurers, multiline insurers, and insurance brokerage firms.

The Fed's FOMC meeting of September revealed that growing support within Fed officials to start tapering the $120 billion per-month bond-buying program from this year and a hike in the benchmark lending rate in the second half of 2022. A reduction in bond buying will push bond prices down. This will increase the yield to maturity of bonds. Higher bond yields will raise the market's risk-free returns.

Insurance providers are generally compelled to hold lots of long-term safe bonds to back the policies that are written. A higher yield of bonds will benefit insurance companies. The spread between the longer-term assets and shorter-term liabilities will increase the spread of insurers. Moreover, the profitability of the insurance industry rose historically during the period of rising interest rates.

Our Top Picks

We have narrowed down our search to five large-cap (market capital > $10 billion) insurers that have strong growth potential for the rest of 2021 and saw positive earnings estimate revisions within the last 60 days. Each of our picks carries either a Zacks Rank #1 (Strong Buy) or 2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

The chart below shows the price performance of our five picks year to date.

Zacks Investment Research
Zacks Investment Research

Image Source: Zacks Investment Research

MetLife Inc. MET is performing well on prudent underwriting and expense management. Several accretive acquisitions led to business diversification and inorganic growth. Business streamlining over the years via divestitures has aligned the company with high-growth operations. It continues to focus on businesses with growth potential and fix or exit businesses that do not create value.

This Zacks Rank #2 company has an expected earnings growth rate of 29.6% for the current year. The Zacks Consensus Estimate for current-year earnings improved 10.8% over the last 60 days.

Aflac Inc. AFL continues to maintain strong risk-adjusted capital at its operating subsidiaries supported by consistent earnings and good liquidity. Its U.S segment is poised to grow from the buyout of Argus Dental and Vision and Zurich North America's U.S. Corporate Life and Pensions (Group Benefits) business. A robust product pipeline for 2021 is likely to boost the segment’s sales going forward.

This Zacks Rank #2 company has an expected earnings growth rate of 12.7% for the current year. The Zacks Consensus Estimate for current-year earnings improved 7.1% over the last 60 days.

American Financial Group Inc. AFG is an insurance holding company, provides specialty property and casualty insurance products in the United States. The company is actively involved in startups, small-to-medium sized-acquisitions, and product launches. Better industry fundamentals, a high renewal ratio, and a favorable combined ratio should drive growth. A solid capital position enables it to deploy capital effectively.

This Zacks Rank #1 company has an expected earnings growth rate of 8.8% for the current year. The Zacks Consensus Estimate for current-year earnings improved 22.4% over the last 60 days.

Fidelity National Financial Inc. FNF is one of the nation's largest title insurance companies through its title insurance underwriters. It also provides flood insurance, personal lines insurance and home warranty insurance through its specialty insurance business. The company is a leading provider of outsourced claims management services to large corporate and public sector entities through its minority-owned subsidiary, Sedgwick CMS.

This Zacks Rank #2 company has an expected earnings growth rate of 24% for the current year. The Zacks Consensus Estimate for current-year earnings improved 7.8% over the last 30 days.

Markel Corp. MKL is a diverse financial holding company that markets and underwrites specialty insurance products in the United States, Bermuda, the United Kingdom, rest of Europe, Canada, Latin America, the Asia Pacific, and the Middle East. It strives to grow through acquisitions and organic initiatives as these not only diversify and strengthen its portfolio but also expand its international footprint.

This Zacks Rank #2 company has an expected earnings growth rate of more than 100% for the current year. The Zacks Consensus Estimate for current-year earnings improved 2% over the last 7 days.


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MetLife, Inc. (MET) : Free Stock Analysis Report

Aflac Incorporated (AFL) : Free Stock Analysis Report

American Financial Group, Inc. (AFG) : Free Stock Analysis Report

Markel Corporation (MKL) : Free Stock Analysis Report

Fidelity National Financial, Inc. (FNF) : Free Stock Analysis Report

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