What’s in store for the big six?

Canadian banks reported their earnings at the end of May and stock prices have essentially declined since then. Should investors be concerned about their bank holdings?

For the most part the quarter was uneventful and the results were reasonably in line with expectations. We saw similar patterns among the big six banks as retail banking results improved year-over-year, but fell short quarter-over-quarter. Most net interest margins fell, loan loss provisions were relatively in check, and capital levels were solid.

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We thought the banks had an opportunity in their wealth management and capital markets businesses to capitalize on strong equity returns during the quarter and it was evident through the results that some banks had done just that, while others struggled.

It’s worthwhile reminding investors that bank CEOs have been trying to lower earnings growth expectations for some time now and analyst estimates are now reflecting this tone, as all of the big six are forecast to have earnings growth in the single digit range in fiscal 2013 (fiscal year end is October 31). So, should investors expect a surge in earnings growth to push the banking sector higher?

No. At the same time, the banks have not entered a period of earnings contraction, so we don’t believe investors should panic and sell due to the declines we’ve seen in the bank share prices since the end of last May. The most common concern that we hear about the banks is personal lending and the housing market. Don’t Canadians have too much debt? When interest rates move higher in Canada won’t housing prices fall, making it more difficult for people to pay their mortgages? Shouldn’t we sell now to prevent this activity from hurting future earnings?

We won’t deny that Canadians have increased their borrowing, and it’s very likely housing prices will decline when interest rates appreciate. However, let’s not forget that banks can make money with higher interest rates as well and that recent statistics are suggesting Canadians are no longer expanding their personal balance sheets. Yes, it will be difficult for banks to grow revenues considerably during the remainder of 2013, but they still have the potential to grow earnings and make a lot of money.

In addition, banks have been very active in returning value to shareholders through share buybacks and dividend increases. Therefore, we remain comfortable with investors owning Canadian banks, even though share price returns may not be as strong as we’ve seen in recent years.

TRADING WEEK AHEAD

Have you had enough of the talking heads on television wondering if the Federal Reserve will “taper” its bond purchasing program? I know I have, but unfortunately, there won’t be many events or data points next week that might change the topic of discussion.

Earnings season is essentially over for Q1 and we’re about a month away from hearing from Alcoa and starting the Q2 earnings parade. There are a few companies providing reports next week, such as Lululemon Athletica and Dollarama, but these reports are unlikely to move the markets.

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Outside of the United States, investors will likely keep their eyes on Chinese trade data (released over the weekend) and the Bank of Japan meeting next Tuesday. The Japanese central bank is well into pushing its new policies, so now the government will have to step up and pursue some fiscal and structural reforms.

Within North America, economic data will focus on housing in Canada while U.S. data will predominantly focus on retail sales, inflation and consumer confidence. This data could be the primary driver for commodity prices along with the Chinese import/export data expected over the weekend. Oil prices have held up reasonably well in what is still a tricky global economic environment, so data from countries such as China will be watched closely.

The ongoing saga with gold prices will continue, especially after bullion fell so hard on Friday. It’s difficult for gold bulls to make a strong argument for a return to higher prices, as the Federal Reserve is more likely to reduce than expand monetary policy going forward when changes in bond buying programs are eventually made. The Canadian dollar rebounded strongly on Thursday/Friday and commodity prices will likely need to see further support next week if loonie strength momentum is going to be maintained.

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Gareth Watson is the Vice President, Investment Management & Research at Richardson GMP in Toronto. This team of research experts is responsible for monitoring and interpreting economic, geo-political situations, current market environments and trends. @Gareth_RGMP