Can strong earnings season pull bank stocks out of their lull?
Rising interest rates, tax cut in U.S. should help boost third-quarter results
It has been a relatively slow year for Canadian bank stocks. Earnings are ticking up, but share prices haven’t all kept pace.
There are hopes, however, that the start of what is expected to be another solid earnings season this week will give bank shares a shot in the arm as they close out 2018.
The third-quarter results from the Big Six will start rolling out on Wednesday, when Royal Bank of Canada reports earnings. RBC will be followed by Canadian Imperial Bank of Commerce on Thursday, and then Bank of Montreal, Bank of Nova Scotia, National Bank of Canada and Toronto-Dominion Bank the following week.
While BMO, National and TD have seen mid-single-digit percentage growth in their share price this year, the overall S&P/TSX index for the banks has risen about 1.6 per cent for 2018. The broader TSX composite index, of which the financial sector makes up a significant chunk, is up only 0.7 per cent for the year.
There have been a few concerns hanging over Canadian lenders this year, including new housing market regulations, a high level of household debt and uncertainty created by the renegotiation of the North American Free Trade Agreement.
To get the sector out of its rut this year, it may take another round of rising profits. Bank of Montreal’s Sohrab Movahedi noted recently that “current absolute and relative valuations are right in line with 10-year averages, suggesting to us that higher stock prices will have to come from higher earnings growth.”
Thankfully for them, the banks do have several developments in their favour for their upcoming results, such as rising interest rates and a tax cut in the United States.
CIBC Capital Markets analyst Robert Sedran said their estimates call for average growth in earnings-per-share of nine per cent year-over-year for the bank stocks for the quarter, “solid performance that’s consistent with what we have seen so far this year.
“They have underperformed their own earnings growth so far this year, but we expect the earnings progress to be more closely reflected in the shares in coming months,” Sedran wrote.
Canaccord Genuity analyst Scott Chan noted Canadian bank stocks have actually outperformed the broader TSX Composite since their last reporting period, led by CIBC, Laurentian Bank of Canada, TD and National Bank of Canada.
Chan said that the stronger showing stemmed moistly from the stability in the Canadian housing market, particularly in the Greater Toronto Area, as well as from “solid” equity markets, movement on the NAFTA talks and “increasingly better capital positions.”
“Another good set of results, complemented by positive (earnings per share) surprises (i.e. vs. approximately four per cent last quarter) and annual revisions could continue to help fuel Canadian bank share performance for the balance of the year,” he added.
And history could be on the side of the banks. National Bank Financial analyst Gabriel Dechaine noted that this year is “eerily similar to what we saw in 2017, with tepid performance heading into third-quarter results followed by an 11 per cent rally to close out the year.”
The difference, Dechaine said, is the waves coming from the housing market — where a new stress test for uninsured mortgages that came into effect this year is expected to slow the growth of mortgage originations — and the NAFTA talks, which remain a wild card for all businesses in North America.
Yet the corporate tax cut in the U.S., where some of the big banks have considerable presence, will presumably not go to waste. Central bank rate hikes in Canada and the U.S. have been appreciated by lenders as well, although they could cause customers to tap the brakes on borrowing.
Overall, the situation might prove more tolerable for those who have the stomach to deal with that short-term turmoil.
“For long-term investors,” Dechaine wrote, “we believe it makes sense to look through this issue.”
We expect the earnings progress to be more closely reflected in the shares in coming months.