Bank on the Banks

Canadian banks have just reported their fiscal year end results this month and they reported profitable results during this last year of turmoil in the economy and financial world. According to Scotia’s 2010 Outlook, “The Canadian banks continue to execute well and their financial strength has only improved. In fact, one could easily argue that capital levels at the Canadian banks are too high and that shareholders are not earning enough return for the extra capital that has been raised over the past 12 months. It is for this reason that we believe the banks may make acquisitions over the coming year or return some of that capital to shareholders in the form of share buybacks or even dividend increases.”

Year to date the financial sector of the TSX has increased 34%. Since the low in March, XFN (iShares Canadian S&P/TSX Capped financial index) has gone from $11.66 to about $21.80 today. That’s an 87% increase! Looking at the chart the current price crossed the 50-day moving average back in March, the 100-day moving average in April and the 200-day in May. Since October the current price has struggled to stay above the 50-day moving average but looks to have found some support with consolidation at the 100-day moving average. The price pattern has flattened out which is not surprising given it’s meteoric rise, however, seasonally this is a time that bank stocks in Canada have outperformed the overall market on average. There are no strong indicators to buy or sell from a technical perspective, so keep your eye on any strong breakout patterns in the short-term.

Although Scotia is bullish on Canadian banks over the next year, high expectations have been built into their share prices. The reported P/E ratio for the TMX website for the S&P/TSX Capped Financial Index is about 24 times. Keep in mind that includes all financial companies like life insurance companies and mutual fund companies. That number is also reported on a trailing earnings basis so the question remains will earnings catch up to price. Scotia argues, “It’s also quite possible that we may have seen the peak in loan loss provisions for the current cycle and if this is true then Canadian banks can only benefit as earnings leverage will increase.” They also point out that while the operating environment for the banks still remains challenging as the world emerges from recession and while credit concerns still linger, their diversified revenue streams have provided stability and should continue to do so for the foreseeable future. The last point is that you can usually bank on banks in low interest environments. The only challenge is that the markets are jittery over anything to do with credit as witnessed by the Dubai concerns.