Global Equity Outlook
Q4 2023
Catastrophic Losses Reshape Opportunities for Insurers
California’s slow wildfire season this year felt like a reprieve of sorts for a state often afflicted by natural disasters.
Then came a tropical storm in August. Tropical Storm Hilary, the first of its type to hit Southern California since 1939, flooded the region.
The immediate and most obvious effect of these catastrophes falls on those who have to recoup what they’ve lost. That pain makes its way upward to insurance companies, some of which doubt how much they want to keep doing business in the state.
The Golden State Highlights Challenges for Insurance Companies
California is a microcosm of the broader near-term troubles confronting U.S. insurance companies.
As the chart below shows, an increasing number of severe catastrophes has brought on more claims by insureds.
Figure 1 | The Frequency and Cost of Natural Disasters is Rising Sharply
Source: NOAA National Centers for Environmental Information. Data as of 9/11/2023.
Inflation and supply chain issues during the last two years have made the replacement cost of insuring damaged property much more expensive, whether or not the loss is tied to a natural disaster.
Higher prices for construction materials have made it more expensive for insurance companies to pay to rebuild homes. Rising automobile costs have made it more costly to replace damaged cars.
In these circumstances, insurers ask state regulators to increase premiums to offset the losses. Some state regulators — again, California is a prime example — have been largely reluctant to raise them.
The ill effects on insurance companies show up on their earnings reports.
State Farm in February reported a 130% combined loss ratio in automobile insurance. That means State Farm lost 30 cents for each dollar of automobile premiums it wrote in 2022.
Allstate reported a net loss of $1.4 billion in the second quarter of 2023 because of severe weather.
Insurers Are Leaving California
Allstate’s share price tumbled 17% year to date. That seems troublesome, but as value investors, we see opportunities in well-capitalized insurance companies that can withstand the industry’s challenges.
For one thing, State Farm announced in May that it would stop selling new home insurance policies in California. In a statement, it said historic increases in construction costs and rapidly growing exposure to catastrophes drove its decision to curtail its business in the disaster-prone state.
California’s insurance commissioner started approving rate increases toward the end of 2022 after holding rates largely steady after the onset of the pandemic. Kemper Insurance, a property and casualty insurer, won a 30% rate increase from California regulators.
What’s Next for the Insurance Industry?
We think State Farm fleeing California will cause regulators to approve more rate increases, which will give remaining insurance companies better pricing power in the future.
If these dynamics play out in California and elsewhere, we think well-capitalized insurance companies may have an opportunity to recoup their losses from recent quarters. If inflation continues to cool, insurance companies may receive an additional boost to profitability in future quarters if claims cost less to settle.
Insurance companies face real challenges. Managing and accounting for risk in an increasingly unpredictable world is no easy task. But we think patient and selective investors may see future opportunities in this sector.
Economic Growth, Inflation and Interest Rates Remain in Focus
Global investors will remain focused on three closely linked macroeconomic indicators: the pace of economic growth, level of inflation and direction of interest rates. A U.S. economy that appears more resilient than we expected has somewhat altered our views on these factors.
U.S. inflation has moderated considerably, thanks to the Federal Reserve’s (Fed’s) interest rate increases. Yet amid the rate-hike campaign, the U.S. economy has continued expanding at a stronger rate than many expected. The degree to which consumer spending levels remain intact will guide growth prospects.
The economy’s resilience provided the backdrop for Chair Jerome Powell’s speech at the Fed’s annual conference in Jackson Hole, Wyo. Powell declared the Fed would remain vigilant on inflation “until the job is done,” indicating it would consider additional rate hikes if economic data warrants them.
High Interest Rates May Linger
Though the U.S. economy has been resilient, slowing growth remains likely, particularly with the possibility that higher interest rates will remain elevated for an extended period.
Recent layoffs in the financial and information technology sectors have helped trigger a slight increase in weekly jobless claims. Meanwhile, rising credit card debt and declining savings suggest consumers largely have spent the cash they accrued during the pandemic.
Outside the U.S., the Bank of Japan’s recent pivot from ultra-accommodative monetary policy suggests its interest rates may increase. That may ease the strongest appetite for Japanese equities in decades. Eurozone inflation still exceeds long-term targets. As a result, rates there may remain elevated despite slowing growth that will remain challenged by the war in Ukraine and weakening demand from China.
Narrow Equity Market Leadership Requires Selectivity
Global equity market gains in 2023 primarily reflect a group of technology stocks riding the wave of exploding interest in artificial intelligence (AI). In this landscape, selectivity remains paramount.
Nevertheless, opportunities exist outside the realm of AI. Global travel and mobility have rebounded from pandemic limitations. Airline traffic has surged, with a corresponding impact on orders for new jets and related equipment, which has driven solid performance for stocks in companies supplying them.
The desire of North American companies to move supply sources and production closer to home also represents an important theme. This push for improved supply-chain stability has fed the onshoring/nearshoring trend. It’s one that should benefit suppliers and manufacturers in the U.S., Canada and Mexico.
China Aside, There's Light Ahead for Emerging Markets
Amid Rapid Disinflation, Easier Monetary Policy May Be on Deck
Inflation hasn’t proven as stubborn to arrest in most emerging economies, with deflation actually now arising as a concern in China. Consequently, central banks have room to begin easing monetary policy, potentially propelling EM economic growth into 2024.
China’s economy remains problematic. The recovery from strict pandemic restrictions lifted late last year proved shorter and weaker than expected. That has prompted calls for fiscal stimulus and measures to support a languishing property market. Such action would sustain investment growth. Still, we think China’s equity market likely will remain volatile, even amid increased activity in the services sector and a recent uptick in weak consumer confidence.
Latin America, led by Brazil, seems poised to lead the way for emerging markets in the months ahead. Inflation has moderated broadly and will support a reduction in central bank rate cuts throughout the region. Conversely, Turkey finally has raised interest rates to quell inflation as steady growth has continued despite devastating earthquakes earlier this year.
Road to Recovery for Commodities?
Commodities prices and emerging equities markets tend to rise and fall in tandem. Though spot commodity values have lagged the rebound in equity markets that began last year, this gap appears as if it may soon close.
If it does, South Africa’s otherwise challenging economic environment could improve. Other emerging markets heavily reliant on commodity production, including many in Latin America, also would receive a boost.
That’s certainly the case for rare earth metals such as lithium, nickel and cobalt. These building blocks for electric vehicle batteries should benefit amid the broader global decarbonization trend. Financial incentives targeting climate change in last year’s Inflation Reduction Act aid companies participating in this trend.
Semiconductor Cycle Turns Promising
Global demand for semiconductors has declined sharply from a late 2021 peak but finally appears on the verge of rebounding. Rising demand for electronics and other end markets, including autos and data centers, should help shrink bloated inventories. In addition, producers of chips for specialized AI applications face overwhelming orders.
An upward turn in the chip cycle could last; forecasts project annual demand growth in the high single-digit range through 2030. That would bode well for Asian markets focused on chip production, including Taiwan.
More broadly, the push in developed markets to diversify supply sources for semiconductors should aid industrial and manufacturing firms involved in building out that additional production.
References to specific securities are for illustrative purposes only, and are not intended as recommendations to purchase or sell securities. Opinions and estimates offered constitute our judgment and, along with other portfolio data, are subject to change without notice.
International investing involves special risk considerations, including economic and political conditions, inflation rates and currency fluctuations.
Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.
Historically, small- and/or mid-cap stocks have been more volatile than the stock of larger, more-established companies. Smaller companies may have limited resources, product lines and markets, and their securities may trade less frequently and in more limited volumes than the securities of larger companies.
Diversification does not assure a profit nor does it protect against loss of principal.
Generally, as interest rates rise, bond prices fall. The opposite is true when interest rates decline.
Past performance is no guarantee of future results. Investment returns will fluctuate and it is possible to lose money.
The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.