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Can Canadian Bank Stocks Withstand Economic Headwinds in the Long Term?

The S&P/TSX Composite Index has dropped 2.1% in 2018 as of close on October 9. The overall performance of Canadian markets may be frustrating for some investors, but the domestic economy has managed to overcome headwinds.

The Canadian economy grew 0.2% in July on the back of a strengthening manufacturing sector. Statistics Canada reported that 12 of 20 sectors posted growth in July. This puts the economy on pace for roughly 2% annualized growth, below the 2.9% clip posted in the second quarter.

Fortunately, Canadian officials also managed to put a pause on the trade spat with the United States and the new USMCA is expected to be ratified in the coming weeks.

Canadian negotiators made several concessions but managed to retain Chapter 19 and the cultural exemption clause, which will work to protect key sectors like softwood lumber and telecommunications.

Clarity on the trade book should give investors some relief, but the Canadian economy is still facing major challenges as we look ahead to the next decade.

Back in late 2017 I’d discussed an Organization for Economic Cooperation and Development (OECD) report that showed Canadian households were the worldwide leaders in debt. The housing market has managed to stabilize after a slow start in 2018, but significant risks remain. Rates are expected to climb into the next decade and put increasing pressure on consumers.

Toronto-Dominion Bank (TSX:TD)(NYSE:TD) chief economist Beata Caranci recently stated that Canadian consumers do not have the capacity to carry the country through another recession like they did in the Great Recession. Canada’s high population growth is expected to prop up housing demand, but this will do little to improve debt levels.

Caranci predicts that “It’s really going to hit the fan” as we enter the next decade. “At that point you have high levels indebtedness combined with income stress happening simultaneously.”

TD Bank is still a worthy long-term consideration for investors. The bank boasts over $1.3 trillion in assets, just behind its strongest peer, Royal Bank of Canada (TSX:RY)(NYSE:RY). In the first nine months of 2018, TD Bank has reported adjusted net income of $9.13 billion compared to $7.98 billion in the prior year.

The bank also boasts the largest U.S. footprint of any other Canadian financial institution, making it an attractive target especially after the U.S. economy posted annualized GDP growth of 4.2% in the second quarter.

Hitting a more positive note, National Bank of Canada (TSX:NA) chief economist Stefane Marion projected that the Bank of Canada would re-assess its rate path after hitting the 2% mark. This, he predicted, should work to prevent a major downturn in the housing sector. National Bank stock has climbed 1.6% in 2018 as of close on October 9.

The bank has made impressive strides in its Wealth Management and Specialty Finance sectors. National Bank has its strongest retail footprint in the province of Quebec, where housing has remained stable. Montreal has topped other major metropolitan areas for sales growth and prices increases in successive months.

Should investors continue to bet on bank stocks in the long term?

Canada will eventually be forced to confront its growing indebtedness, but there is still hope for the Canadian economy to beat back declining growth projections going forward. A federal election looms in 2019 and investors can bet that major parties will be floating tax reform packages of their own. Consider the investment outflows Canada suffered in the aftermath of U.S. tax reform.

Canadian banks like TD and National Bank are still worth holding into 2020 and beyond.

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