AQS Performance and Perspective

AQS Performance and Perspective - December 2023

Happy New Year from AQS

We at AQS wish you, your family and your organization all the best for 2024. The challenges of 2023 are behind us now and we look forward to the opportunities of 2024.

A Look Back at 2023

A tightening cycle that began in March 2022, continued as the U.S. Federal Reserve kept the heat on rates, tightening the overnight rate a total of 11 times through 2023.

Quantitative Tightening (QT) that began in June 2022 continued throughout 2023 with longer treasuries (10 yr here) peaking in October 2023. QT, different from the overnight rate, involves the balance sheet runoff of assets purchased during QE.

Mortgages consumed by the Fed during QE now must be consumed by the open market. Mortgage rates are now the highest since the financial crisis. The impact on housing and commercial real estate has been predictable.

Equities which reached the current high in January 2022, have largely ignored higher rates and are positioned to exceed the January 2022 high in or near January 2024.

On October 7, paramilitary wings of Hamas attacked Israel on the day of Sukkot, a Sabbath Day, almost 50 years to the day (October 6, 1973) of the Yom Kippur War. As this conflict continues to unfold, the threat of a broader conflict is the most obvious threat to the nascent global recovery. It is worth pointing out that the obvious is seldom the catalyst of event risk.

Inflation Data - Not Dead Yet but Suddenly Irrelevant

November CPI: 0.1% MoM / 3.1% YoY; Ex-Food & Energy (Core): 0.3% / 4.0%

November PPI: 0.0% MoM / 0.9% YoY; Ex-Food & Energy (Core): 0.0% / 2.0%

The numbers reported by the BLS belie the reality of shopping for groceries and other consumer goods. Most of us see gasoline regularly. Any idea the cost of a roll of toilet paper (the good stuff) costs? Use sparingly! See Americans are Finally Turning Frugal After Splurging Over Summer.

AQS Trailing Reinvestment as of December 27, 2023

This Month

McKinsey & Company Points Out the Obvious?
Will That Eureka Moment Age Well?
The Investment Environment Has Changed.
Reinsurance - Risk Management or More Risk?

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McKinsey & Company Points Out the Obvious -

Will it "Age" Well?

Background

In a February 2022 article, McKinsey & Company pointed out the obvious.

Life insurers, especially annuity companies, enjoyed double digit growth since the financial crisis. Persistent low rates, few credit events and a generally peaceful geopolitical landscape contributed to a perfect storm for companies offering annuity products to consumers wishing to avoid equity market volatility and sub 1% bank deposit rates.

Will That Eureka Moment Age Well?

"Dumb" money is no reflection on the asset manager. Rather, it refers to money allocated to a particular sector. Investors, anxious to achieve promised returns, expect the money to be deployed. As "dumb" money piles into Private Equity (PE), those funds are progressively invested in assets with diminishing returns; hence, the term "dumb". AQS sees a problem lurking that is exacerbated by increasingly "dumb" investment.

The Investment Environment Has Changed Too

Rates are No Longer Low

Quantitative Tightening (QT) pushed (short) T-bill rates to 5.50% and more. While this is good for life and annuity company reinvestment, it also causes unwanted competition for annuities including bank CDs, T-bills and money market funds.

Equities Continue to Outperform

While equities represent a different type of risk, the allure of double digit returns pulls money out of hiding in money market funds. Of course the oppossite is true as well. When equities underperform, annuities and other fixed income assets tend to be the beneficiary.

Nosebleed Competing Annuity Rates

A few commercial companies in the annutiy space continue to offer ever-higher rates. To fund these offerings, these issuers typically take on more risk. More sophisticated? It would appear so; however, a full market cycle will likely create some "mean reversion" - sophisticated risk that doesn't work out.

Reinsurance - Risk Management or More Risk?

The giant catch all combining offshore investment, a relaxed regulatory environment and "bull market sophistication". Many reinsurers use the same life and annuity asset managers that are available to ceding companies. How then do they achieve such outsized returns? They take more risk. The ceding company is ultimately responsible to the policy holders for bad reinsurance choices.

AQS sees 2024 as a continuing challenge for life and annuity insurers. As short-term rates dictated by the Federal Reserve remain high and longer rates continue to fall (an inverted yield curve), we expect the more aggressive insurers and reinsurers to take on more risk.

Seldom is there a smooth landing. However as most pilots will point out, "any landing you walk away from is a good one."