The outlook for banks and insurance companies is bright this year, says equities expert Stephen Carlin.
Banks, in particular, will continue to deliver positive earnings growth, says Carlin, managing director and head of equities at CIBC Asset Management, which offers funds such as the CIBC Canadian Equity Fund.
As of late April, “valuations for the banks were trading at 11 times earnings,” he said. “But when you look back at history, they’re not overpriced right now. When we look at the dividend profile, coupled with the earnings growth prospects and an attractive valuation, we see the Canadian banks as generating solid double-digit returns for investors this year.”
One insurance company he likes is Manulife, which reported in early May that its Q1 2018 net income attributed to shareholders rose 1.63% to $1.372 billion, or $0.67 per share.
Even while the financial sector “has taken a bit of a pause or a breather on some concerns related to rising interest rates and a higher level of volatility in the stock market, […] we think those issues are largely noise,” says Carlin. For insurance companies, he says “there’s room for expansion in the ROE, [or] return on equity profile, for the businesses over the next 12 months.”
One boon for insurers is an “improving macro environment” contributing to earnings and business growth.
Canada’s real GDP grew 0.4% in February while inflation started the year at 1.3% in January and rose to 2.3% by March. The unemployment rate in April stayed at 5.8% for the third month in a row. Since the start of the year, when the BoC raised the policy interest rate 0.25% to 1.25%, it’s stood pat.
Carlin acknowledges the TSX has seen its share of volatility this year (as of May 17, the S&P/TSX Composite Index was down 0.41% year to date) but that hasn’t dampened his view on financials overall.
He likes the outlook for both Manulife and Sun Life, and has “emphasis” on both names in the portfolio.
Banks’ exposure to real estate
Carlin says it’s worth monitoring banks’ real estate exposure. However, he doesn’t think the risk is as serious as some investors believe.
The key thing to consider in relation to the housing market is employment, which is “very strong,” he says. “[When] folks have jobs, folks can service their mortgages.”
Carlin also looks at credit trends when assessing banks’ weaknesses. “Consumer credit trends continue to remain strong, and so there are no early warning signs […]. We read heavily that the consumer has a higher debt profile, [but] consumers are still servicing their debt in a satisfactory fashion.”
The latest figure for the household debt ratio shows Canadians hold $1.70 in debt for every dollar of disposable income. But, over the coming years, that ratio is expected to stabilize, BoC senior deputy governor Carolyn Wilkins told a parliamentary committee in April. She explained that people’s debt buildup has included asset purchases such as houses, which also points to higher net worth.
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