Recession fears weigh on bank stocks

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The SHARE COMPASS is a section that deals with a significant event and its effects on the stock market based on expert analysis. This analysis can be both fundamental and technical.


(Illustration: Camille Charbonneau)

The latest quarterly results of the major Canadian banks, published a few weeks ago, do not seem to excite neither analysts nor investors.

However, these stocks often perform well in the second half of the year, remembers National Bank Financial analyst Gabriel Dechaine. In fact, banks have performed better for this period than the entire Canadian stock market 60% of the time for 20 years. But it won’t be like this this year, he said. “Although the current valuation of banking stocks looks cheap, with a price-to-earnings ratio at the bottom of its historical range, this valuation remains at risk given the likelihood of a recession,” he wrote in a recent report. That ratio, which is usually between 10 and 12 times, has now dropped to 10 times, he estimates.

Bank stock prices already include a lot of bad news, said Doug Young, an analyst at Desjardins. But reaching higher levels may take some time, he says. “The performance of financial company stocks is generally not very good as we approach the end of a business cycle. In the current context, it is therefore difficult to believe for the moment in a significant expansion of the valuation multiple, “he wrote.

Provisions for losses

If the latest quarterly results of the six big banks were somewhat disappointing, it is because they all increased their loss provisions, which they had done for the first in six quarters. Recall that when the pandemic arrived, the banks had entered large provisions in their balance sheets, creating heavy losses on paper. But for a year and a half they had been paying a portion of these provisions every quarter, which had the effect of increasing profits.

Taking into account these loss provisions, the operating profits of the six big banks in the third quarter were 14 billion, or 5% less than in the same quarter of the previous year, estimates Sohrab Movahedi, analyst at BMO Markets.capital. Loss provisions show that bank executives believe economic indicators are now less conducive to economic growth and increased volume of banking assets, he said.

Capital markets

Last quarter results showed strong resilience in retail and business banking thanks to solid loan growth and expanding spreads, both domestically and internationally, says the BMO analyst. However, this strong sector performance was partially offset by a significant decline in earnings from capital market operations, including arbitrage, new issues and advisory fees. The same is true for the entire wealth management industry, which has had to contend with weakness in the equity and bond markets. As a result, Sohrab Movahedi says he is more cautious about banks’ income prospects, which leads him to lower his target prices, among others for the CIBC and the National Bank (NA, $ 91.66). Additionally, the analyst downgrades one of the banks, Scotia (SNB, $ 71.82), which ranges from “outperformance” to “market performance”.

The technical analyst

The stock prices of the six major Canadian banks generally move in the same direction, but with sometimes different highs and lows. This is why the analysis of the performance of the Royal Bank (RY, $ 126.92) also applies to those of other banks, explains Monica Rizk, senior analyst at Phases & Cycles Publications.

The share price of Canada’s largest bank is now at a critical level, he said. After a dramatic rally that saw the stock double in less than two years from the low caused by fears of a pandemic-related recession, the stock fell sharply until mid-June.

However, the stock then recorded an interesting rebound that allowed it to move closer to its 200-day moving average, thus suggesting that the trend could be reversed. But the recovery did not resist and the stock returned to test the previous low, around $ 120. “This level is now a very important support which should not be broken down as it would indicate that the downtrend is still firmly in place,” says Rizk.

For investors to regain some optimism towards the stock, it should now stabilize and recover to a base of between $ 125 and $ 135 from which it could eventually find a sustained upward trend, the analyst believes. But it will probably take a few months to get fixed, according to her.

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