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Dr. Brett Steenbarger (author of Enhancing Trader Performance and the blog TraderFeed) and I have collaborated on an analysis of American International Group, Inc. (AIG), to provide readers two sides of the same stock. The beginning of the analysis is my take, dissecting a longer term trend, while Dr. Brett has provided his usual succinct short-term trade direction in "technicals". We thank all readers in advance and hope this adds value to your trading and investing.

Fundamentals

The retiring baby boomers in the domestic market, AIG’s diverse distribution network taps significant opportunities overseas while new product releases are expected to support growth in Life Insurance operations going forward.

General Insurance Division

I expect net written premium growth from the Domestic Brokerage Group, which advanced a normalized 7% YoY in 3Q 06 to remain in the mid-to-high single-digits in 07—among the best growth rates in the industry as AIG continues to expand its distribution and to capitalize on dislocations in coastal-exposed property insurance businesses.

In 07, I think the DBG loss ratio will move up modestly as the adverse impacts of competitive commercial lines pricing is partially offset by reserve releases. And, expense ratios likely will be in the 18-19% range, which are in-line.

In 08, Wall Street projects NWP growth to slow to the low single-digits and the combined ratio to rise above 90% as the market becomes increasingly competitive and loss costs increase.

Wall Street expects high single digit annual NWP growth over the next few years, driven by increased distribution, its new segmentation strategy, and higher Ascot syndicate premiums in Foreign General side.

However, personal accident sales may weaken, particularly as competitive pressures in Japan increase. Wall Street expects loss ratios to increase modestly over the next year as the impact of competitive pricing in commercial lines and less favorable weather is partially offset by loss reserve releases.

Financial Services Division

I'm looking for earnings to rise roughly 6% in 07, with international growth more than offsetting a double digit drop at American General Finance, which likely will suffer from lower interest margins and higher credit provisions. In 08, Wall Street is projecting 7% earnings growth, supported by mid single digit net receivable increases at American General Finance and double-digit international revenue progression

Life Insurance & Retirement Services Division

In the Domestic Life area I anticipate mid single-digit earnings growth (3% in 07 and 5% in 08), largely due to the run-off annuity block, spread pressures in the fixed annuity business, and challenges at AIG VALIC as a result of an aging in-force block.

However, Wall Street thinks individual variable annuity earnings could grow at a low double digit rate, helped by improving net flows and equity market appreciation. I also think life insurance earnings could advance at an upper-single-digit annual pace, supported by higher than industry top-line growth and scale benefits.

Asset Management Division

Quarterly institutional results are usually volatile due to performance-based fee income and real estate gains. That said, Wall Street is projecting quarterly institutional earnings to average $110 million in 07 & $120 million in 08, higher than the average $106 million earned in 05 and $104 million generated in 06 thanks to AUM growth.

Brokerage Services

I'm expecting 11% and 15% bottomline growth in 07 and 08, respectively, supported by double digit third party AUM growth and assuming positive equity markets.

Analyst earnings forecasts for AIG have increased, which indicates a rise in expected earnings growth. Hence, relative to changes in earnings forecasts for other companies AIG compares favorably. Furthermore AIG has reported earnings that were higher than those predicted in earlier estimates which may be a positive for future earnings growth.

Technicals

Since 2004, AIG has rather noticeably underperformed the S&P 500 Index (SPY). As the chart below shows, AIG is currently trading at almost the same place it opened 2004, while the S&P 500 Index has moved steadily higher.

Over the past three weeks (15 trading sessions), AIG is up by about 2.5%. When we have a rise in AIG over a three-week period, does it pay to follow the "trend", can you expect lower prices ahead, or has it made no difference whatsoever?

I examined the period from January 2, 2004 to November 29, 2006 [N = 734 trading days] and compared three-week periods in AIG that were flat or up [N = 443] to those that were down [N = 291]. Specifically, I wanted to see how AIG has performed over the next three-week period.

click to enlarge

AIG vs SPY

When AIG has been up over the past 15 trading sessions, the next 15 sessions in AIG average a gain of .49% (267 up, 176 down). Conversely, when AIG has been down over the past 15 trading sessions, the next 15 sessions have averaged a loss of -.27% (167 up, 124 down).

Visual inspection of the above chart suggests that, since the start of 2004, AIG has been moving in swings of longer than 15 days. This creates a situation in which returns have been better following strong 15-day periods than following weak 15-day occasions. The S&P 500 Index, despite its relative strength compared to AIG, has traded in a choppier fashion. It has shown mean-reversion tendencies over periods from 2-20 days out in my recent investigations.

The moral of the story is that it is important to know how your instrument trades before making trading assumptions. It is common to hear that a stock is "overbought" because it's been up for several weeks straight. The implication is that the stock is due for a fall. In the case of AIG, that casual logic hasn't held water over the past three years.

Note: A special thanks to Dr. Steenbarger who insisted my name be mentioned first, along with my analysis. Goes to show his truly humble and modest nature, a big requirement if you want to succeed in the business.

Source: Short and Longer Term Directions For American International Group