Many investors were steering clear of Canadian bank stocks in mid-December as the fallout from plummeting oil prices, low-interest rates and elevated housing prices zapped confidence in what had been one of the country’s most resilient sectors.
But David Rosenberg was convinced the fading shares of the Big 5 banks were an opportunity not to be missed. It was exactly the type of contrarian call that the market has come to expect from the well-known chief economist and strategist at Gluskin Sheff + Associates Inc.
“I think the Canadian banks are crown jewels,” he said in an interview this week. “So when they are down 10% and we are not in a recession, you want to press the buy button.”
I think the Canadian banks are crown jewels
Mr. Rosenberg’s belief back then was temporarily rewarded as the banks rallied 5% soon after, but his war cry ultimately fell on deaf ears and the banks dropped 10% early in the new year. More than two months on, share prices continue to seesaw, but he and other bullish proponents of the country’s biggest banks may finally be getting the upper hand.
Shares in Canada’s biggest banks are up 3.25% since Tuesday’s close following an unexpectedly positive first-quarter earnings season that has seen three of the four banks that have so far reported top analyst estimates and announce dividend increases.
“The banks are resilient animals and that has once again come through in the quarterly results,” said Murray Leith, vice-president and director of investment research at Odlum Brown Ltd. in Vancouver.
“Investors feared the worst and, consequently, the bank stocks performed poorly heading into earnings season. You could call the reaction to the results a bit of a relief rally.”
Barry Schwartz, chief investment officer at Baskin Wealth Management in Toronto, said most investors don’t fully appreciate how well diversified Canada’s banks are geographically and across business segments.
“There are so many levers and drivers of bank earnings and sometimes one thing is positive for one part of the business, but negative for another part of the business,” he said.
As a result, he believes people lost their perspective about the potential negative impact lower oil prices would have on the group, which has been nominal to date.
“Everybody lost their minds, saying low oil would cause rippling, cascading loan losses and mortgage losses,” he said. “Admittedly, it could still happen, but I think it was a knee-jerk reaction.”
Mr. Schwartz also blamed short sellers, many of whom reside south of the border, for causing much of the recent investor angst without really understanding the dynamic of the Canadian market.
“If someone yells fire, you pay attention whether they’re right or not,” he said.
Now that most of the banks have emerged unscathed, at least so far, Mr. Schwartz expects the majority of investors to reassert their love of the country’s banking sector, which has consistently proven one of the best investment bets during the past 50 years.
“The banks deserve to trade at a premium and at much higher multiples than today even if there isn’t a lot of growth,” he said. “I see potential if we get past a couple of quarters for a 20-to-30% gain for the banks in a very short period of time.”
If someone yells fire, you pay attention whether they’re right or not
Of course, not everyone is racing to load up on the banks and analysts who cover the sector remain cautious.
Dividend increases, including the surprise hike by Canadian Imperial Bank of Commerce, and attractive yields should garner support from the fixed-income crowd, analysts said.
But John Aiken, analyst at Barclays Capital, added that revenue pressures are likely to continue in what is still a challenging macro environment for the banks, and that will keep a tight lid on further share price gains.
If anything, analysts say, investors need to be selective about their picks, recognizing each bank’s individual strengths and weaknesses.
For example, National Bank analyst Peter Routledge said Toronto-Dominion Bank’s U.S. retail platform is a key pillar of his outperform thesis on the stock.
TD’s U.S. segment exceeded his first-quarter estimate and maintains a positive gearing to a rising U.S. interest rate environment, but revenue growth has yet to accelerate and year-over-year operating leverage remains negative.
“Thus, TD has yet to fully realize our expectations,” he said in a note to clients. “We would describe the quarter as good, not great.”
On the other hand, Mr. Routledge said CIBC is expected to be the hardest hit by a “soft” deleveraging of the Canadian household.
“We expect CIBC earnings will remain flat over the next two years, while dividends will rise gradually,” he said. “As a result, we view CM as a yield play until macro-economic conditions strengthen.”
Mr. Rosenberg agrees that buying the right one or two banks in any given year can add significant torque to a portfolio.
“The banks are correlated, but there is usually a sizable gap between the best and the worst,” he said.
Even so, Canadian banks, as a group, have long been a safe bet, recording a positive 12-month return for investors 85% of the time over the past 30 years, and Mr. Rosenberg doesn’t expect that to change.
The ratio between the dividend yield of the banks, now near 4%, and what you can garner in the Canadian government bond market has never been so alluring, he said.
At the same time, the global economy appears to be in better shape than it was three months ago. Even though Alberta’s economy is “going through the ringer,” Mr. Rosenberg doesn’t believe the province will drag the rest of the country into recession. In fact, lower oil prices are a huge blessing to Canada’s manufacturing sector.
“To me, there’s no such thing as a no-brainer in the business, but this is as close as you will ever get,” he said.