(January 15 – 17:45 ET) – A new report from Merrill Lynch sees more downside for Canadian life insurers.

Merrill says that although the stocks of domestic life insurers dropped 3.9% last week, knocking 15% off their prices so far this year, the insurers face more selling pressure. “We continue to view current valuation levels with some degree of trepidation and therefore recommend selective profit taking amongst those companies where in our view market valuation has substantially exceeded our fair value estimates,” says Brad Smith, senior equity analyst, in his report.

Merrill notes that the economic numbers out in the U.S. last week, including higher than expected retail sales and the Producer Price Index, sparked a 15 basis point jump in U.S. AAA corporate bond yields. This in turn shaves 0.3 off its fair value P/E estimate for insurers to 14.7 times.

With earnings season for insurers right around the corner, and relatively low volumes traded so far, Merrill expects more selling in these stocks. It expects that earnings momentum will slow due to the stumbling equity markets.

It also expects that stock prices will fall from last year’s run up in insurers. “Although the degree of price deterioration has been substantial on a year-to-date basis, the volume of shares traded during this recent correction at 38 million pales by comparison with the 270 million shares traded as sector prices rose during the final four months of 2000.”

Great-West Lifeco remains Merrill’s top pick in the sector.