Hitting for the Cycle

I find today’s markets confusing and contradictory.

Where are we in the cycle?

Clearly the insurance cycle is clear – we are in price freefall.

However, in the cycle of efficient markets, we are still writing the history of subprime and its impact on global markets.

Going back to the great quote (here) about the daily losers in the global game of subprime hide and seek, credit market insiders reveal that it’s worse than most know. I there is one constant theme across everyone I know on credit desks, it’s that the worst is yet to come.

Take the story I heard over Sunday brunch about how buyers of loans can’t buy performing loans without having to agree to take on the non-performers that could destroy their chances of good performance. In a rush against the clock, banks are hoping to off-load these non-performers before write-down Judgement Day.

So if it’s going to get worse, why is there price support in the capital markets?

Reading a quote by James Paulsen, Chief Investment Strategist at Wells Capital, a Wells Fargo company, I was struck by his assertion that the housing market malaise has not impacted consumer spending. He’s bullish on stocks. Further, he cites how the falling US Dollar is helping reverse a trend of net exports and that rising value from exports is having a material effect on GDP (appx 1.5%).

Another article in the same magazine talked more about what’s next - that eventually the write-downs will ebb (we estimate that will be at $440B and we’re only just over $260B); that some clever structured finance groups will find another match good investment money with need for good capital needs in a variety of good vehicles, that these vehicles will be securitized and that the bond insurers will have something new to back. Efficient markets win again.

Where are we in the impact of subprime on the insurance industry?

We’re in the denial stage. Advisen data shows clearly that pricing is not affected yet, even among banks buying D&O. As unbelievable as this is (and note that Aon published numbers showing an increase of 18% - see here), one savvy insurance insider told me today in London that the D&O market is not likely to change with the first claims but instead wait until the first reserves are hit. There’s just too much money chasing underwriting profits.

Much like the litigation and resulting D&O hard market came to life years after the investment impact of the corporate scandals of Enron and WorldCom, subprime will be a story for the insurance market in 2010 while the capital markets are onto something new.

As an information provider to commercial insurance providers we constantly review whether we are ahead of the information demand curve – are we providing what our customers need? Recent comments from brokers and underwriters indicate “a subprime fatigue” and one even said that there is “too much analysis”. These comments only make sense if profit-hunting will continue until it’s way too late.