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Firm quarter, murky outlook seen for lifecos

Analysis: Stronger stock markets and rising bond yields likely stoked profits at Canada's life insurers during the first quarter, but a recent market reversal suggest the insurers' shares will struggle to build on recent gains.

Top player Manulife Financial (MFC-T) will kick off the sector's results on Thursday and is expected to post a profit of 32 cents a share, according to Thomson Reuters I/B/E/S. That represents an improvement on losses in both the third and fourth quarters of 2011.

"It'll be the first quarter where we've had uniform positive EPS (earnings per share) across the sector in three quarters. In that sense it will be a very good quarter," National Bank Financial analyst Peter Routledge.

Routledge then added the caveat: "But that's backwards-looking."

With stock indexes and bond yields having come substantially off their first-quarter peaks, investors are unlikely to be impressed by the stronger results, he said, as renewed market weakness points to more hardship in the second quarter.

"It'll be a good quarter, but no one will be worried about that, they'll be worried about what risks still exist," he said.

Under Canadian accounting rules, life insurers must keep adjusting their projected returns from the huge investment portfolios that back their policy obligations. Negative market moves force them to take reserves out of profits.

In the first quarter, the S&P/TSX composite index rose 3.7 percent, its best quarterly gain since early 2011. And Canada's 10-year bond yield, which hit a multi-decade trough of 1.84 percent in December, climbed to a 2012 high of 2.3 percent in March.

The moves in both markets will pad insurer results.

But since the end of March, investors have taken fright from fresh signs of trouble in Europe's debt crisis and unexpectedly weak U.S. economic data. This has sent Toronto stocks down more than 1 percent this month. Bond yields have dropped as investors have shifted back into the safe-haven market.

With the companies' shares still more or less riding the euphoria of the early market rise, analysts warn the stage could be set for a retracement.

"We believe the stocks have likely captured the upside sentiment going into results, so a miss could be met with a near-term sell-off," Scotia Capital analyst Joanne Smith said in a note.

YEAR-TO-DATE STRENGTH

Manulife shares are up 26 percent year to date, while Sun Life Financial (SLF-T) has risen 29 percent, and Industrial Alliance (IAG-T) is up 20 percent.

Great-West Lifeco (GWO-T), which has a much smaller exposure to markets than its rivals, is up 22 percent.

While the percentage gains sound lofty, the climb is from the multi-year lows the stocks hit late last year, and the shares of all four insurers are substantially below their levels of 12 months ago.

"We're sort of playing it like a call on the markets, if you like, rather than the nitty gritty day-to-day core businesses," said Caldwell Securities portfolio manager John Kinsey, who recently bought shares of Sun Life and Manulife.

CORE IMPROVEMENTS, HEDGING

While the insurers' results are still dependent on market moves, the volatility has come down substantially from two years ago due to hedging by the companies, as well as a repositioning away from market-sensitive businesses.

Indeed, analysts say the core operations of the companies are improving, and they have been heartened by developments such as Sun Life's stated objective last month to boost its operating income to $2 billion by 2015 from $104 million last year.

Many think the quality of the insurers' businesses is high. Manulife, for instance, is dominant in Canada, growing in Asia, and owns U.S. insurer John Hancock. And while the companies' share prices may be a bargain compared with that quality, analysts say investors may be jumping the gun by buying on recent market moves.

"I don't think you need to aggressively chase these things, when they are trading at premiums to book value," said Robert Sedran, an analyst at CIBC World Markets.

"I think we're in a market where a lot of these macro risks that they're dealing with haven't vanished."

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