Three stocks to buy as the market turns down

By Associate Editor David Stevenson Jan 29, 2010

David Stevenson

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Lloyds of London insurance building © Shutterstock

LLoyd's of London: non-lifes are back in favour

The stock market has suddenly got lots to worry about, as we noted in yesterday's Money Morning. And these problems aren't likely to go away overnight either. They all look like they could run and run.

So it's not a great time to be invested in expensive, high-risk, cyclical shares which don't yield much and have already risen a long way.

But what can you invest in instead? Well, there's a sector that's cheap, low-risk - and which yields some 70% more than the overall market…

Which sector looks cheap right now?

The bulls think everything will soon be 'back to normal' again. Which is why they've happily chased up the prices of cyclical businesses that do well when growth is good.

The trouble is, there's no good reason to expect a sustained economic recovery. From the extremely weak UK GDP growth figures (The recession is over - but for how long?) to the drop in retail sales seen in January (according to the Confederation of British Industry), the danger signs are already growing again. As are the hazards of holding cyclicals, which have become a lot more expensive over the last year.

So cheap, relatively low-risk, high-yielding defensive sectors feel like the right place to be at the moment. And you can't get many cheaper, or indeed better-yielding, stocks than those in the non-life insurance business, as I'll explain in a minute.

What do non-life insurers do?

But first, what do companies in this business actually do? What they say on the tin basically. They supply products to meet pretty well every insurance need apart from life cover. In other words, they won't insure you against falling underneath a bus, but they'll provide cover for damage to the bus itself.

'Non-lifes' take on a wide range of risks, which individually can be unpredictable. So they have to ensure that the premiums they charge are large enough to meet any claims. The latter can often take many years to settle. In the meantime, these insurers can invest their premium income to generate extra returns. But because they must ensure that there's enough cash in the kitty on payout day, they can only invest in low-risk assets. This means that if it's done properly, non-life insurance is actually a relatively low-risk business to be in.

Why non-lifes have been out of favour - until now

So in the stock market's 'dash for trash', it's a sector that has been right out of favour. Softening insurance rates, which curb profits in the short-term, have also been a negative. Look at the Bloomberg chart below...

[click onthe chart for a larger version]

The red line is simply the FTSE All-Share index. The blue line shows the performance of the UK non-life sector compared with it.

Over the last two years, these have been almost a mirror image of each other. Non-life shares were great for your portfolio while the overall market nearly halved between May 2008 and early-March 2009. There were a few wobbles - at its worst point, the sector index fell by 18% - but on balance, if you were smart enough to be a shareholder then, you emerged from that period with your capital intact. In short, you completely sidestepped the carnage elsewhere.

But it's been a very different story over the last year or so. Holding non-lifes throughout would have meant largely missing out on the latest major market rally.

Until the last two weeks of market tremors, that is. Because the market mood now seems to be turning again – back in favour of non-lifes. And if there are plenty of economic aftershocks to come, as we expect, then investors will soon realise where they need to park their stock market money.

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Three stocks to protect your portfolio

So what should you be looking buy?

Within the non-life sector there are the big boys, such as worldwide commercial insurer RSA (LSE: RSA). Previously known as Royal Sun Alliance, it has a market cap of £4.4bn and is a FTSE 100 member. At 129p, RSA is cheap on a p/e of just over nine for 2010 and a prospective yield of 6.7%. If your preference is for mainstream 'blue-chip' stocks, this is probably the one for you.

The alternative is to look at the smaller fry – the quoted 're-insurers' at Lloyd's, which is the world's leading underwriting market. (If you want to know more about Lloyd's, we wrote about it in MoneyWeek magazine last year: How to become a Lloyd's Name).

These Lloyd's companies provide insurance to other insurers by taking on some of their risks. The average yield among the quoted Lloyd's insurers is 5.7%. That's around 70% higher than the current yield on the FTSE All-Share index.

But some could give you an even better return. Right now, the pick of the bunch, dividend-payment wise, is England cricket sponsor Brit Insurance (LSE: BRE). Thomas Dorner of Oriel Securities says that at 186p, this is on a p/e of just 5.7 and a forward yield of 8.6% - as well as price/net asset value of 0.67, i.e. you're buying £1 of assets for 67p. He reckons that's "compelling value".

Finally, there's my favourite, Catlin Group (LSE: CGL). Last December, Standard & Poor's was very nice about Catlin, saying that "the company's capital position has improved and will prove resilient to the growth expectations of the group". S&P raised the firm's financial strength score to A. (Greece (BBB+) – and several other sovereign states – eat your heart out!)

At 343p, Catlin is on a p/e of just over six, says Dorner, a prospective yield of 7.6% and an 11% discount to net assets. Even after any possible hit to profits from those lower premium rates, that's cheap.

Our recommended article for today

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Comments (7)

Published in Tips & advice | More articles by David Stevenson

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  • 1. Paul from Essex

    (29 January 2010, 11:25AM)  Complain about this comment

    Non-Life Insurance, I would be interested if anyone knows what derivative exposure these companies have? Have they been issuing CDSs etc? Would a hint of a second financial crisis send them down the pan?

  • 2. Damian from London

    (29 January 2010, 11:41AM)  Complain about this comment

    Looking at the article it appears that a disparity exists across the P/E ratios of these companies within the same industry. RSA has a P/E of 9 while BRE has only 6.
    Presuming that the P/E ratio is an accurate method of calculating a company's valuation would a pairs strategy (i.e. short RSA long BRE) on these stock s be worth adopting?

  • 3. IJ

    (29 January 2010, 12:00PM)  Complain about this comment

    Damian, I would personally never short a stock that potentially pays a 6.7% dividend, regardless of whether it's counterbalanced by a long position on one that pays (theoretically at least, and that's the key I guess) an even higher one.

  • 4. John from London

    (29 January 2010, 01:46PM)  Complain about this comment

    I would avoid Brit as they are cheap for a reason. The have big exposure to the financial crisis (Madoff, AIG etc.) through their large book of US proessional indemnity business. Claims from huge class action lawsuits are only just beginning to hit the market and will take another two to three years to develop fully.
    If you want exposure to LLoyd's then Amlin and Hiscox, whilst more expensive from a p/e and price to book perspective, are much better businesses.

  • 5. Timbo

    (30 January 2010, 02:03AM)  Complain about this comment

    After watching last nights very positive GDP figures arrive from the US, and then watching the markets tank again soon after I'm beginning to wonder if cash isn't the safest bet.

  • 6. Michael Lewis

    (30 January 2010, 03:57PM)  Complain about this comment

    Yes, I saw the story on Bloomberg about Lloyds name too.

  • 7. Nick F

    (01 February 2010, 11:27AM)  Complain about this comment

    The graph of the UK non-life sector does NOT support the conclusions in this article! The graph is UK non-life sector RELATIVE to the market - it already has the 'inverse of the market' built in. If the non-life sector was flat, then this presentation would appear to show (perfectly) the inverse behaviour claimed.
    In reality, the non-life sector has been roughly flatfor 2 years - the apparent decline in 2009 is purely a result of plotting 'relative to the market'. The argument is nonsense!

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