Royal Bank of Canada (TSX:RY)(NYSE:RY) is one of the most popular stocks in Canada. Its $130 billion market cap also makes it one of the biggest. Yet quite recently, the entire business was worth 30% more, which means the bank moved $30 billion in value in a few short weeks.
RBC is known for its long-term returns. For decades, it generated double-digit annual gains for shareholders. But this sudden upsurge is something new. This stock rarely moves this much so quickly.
Why did Royal Bank of Canada stock surge 30%?
Ride the rollercoaster
Investing in bank stocks is essentially a leveraged bet on the economy. Banks like Royal Bank of Canada only keep a small portion of their capital as reserves. Banks loan the rest out to a wide variety of businesses and organizations.
If the economy stutters, RBC will be directly impacted. It’s therefore little wonder that shares were crushed during the early days of COVID-19. At the start of 2020, the stock was priced at $109. On March 23, the valuation had shrunk to just $70, a 35% decline in a matter of weeks.
It’s not hard to see why Royal Bank of Canada was targeted by the market. While the bank runs a global operation, it will live or die by the health of Canada’s economy. All signs are negative on that front. Canada recently released its worst jobs report in history. Millions are out of work. And while reopening efforts are beginning, the road ahead is fraught with uncertainty.
To make matters worse, Canada will be hit hard by the current energy bear market, which saw oil prices collapse from US$60 per barrel to just US$20 per barrel. This is terrible news considering given that many of the country’s biggest projects break even at prices above US$40 per barrel.
Around 10% of the economy is directly related to energy, contributing billions in annual government tax revenue.
While oil prices have rebounded, they remain well under their long-term average. With billions in energy-related loans, Royal Bank of Canada may experience a sharp uptick in delinquencies as the month rolls on.
Buy Royal Bank of Canada stock?
All of the negative headwinds mentioned above proved no match for RBC stock following the market bottom, with shares shooting higher by 30%. They’re now re-approaching the $100 mark. Why the sudden surge?
A rebound in oil markets have helped, but as mentioned, prices are still lower than they need to be to insulate Royal Bank of Canada from further damage. COVID-19 deaths are also significantly lower than first expected, but the length of the fight could persist for years.
A second wave next winter could be a deathblow to the way we do business. There could be a permanent reduction in economic output, a horrendous outcome for bank stocks.
The stock market seems unperturbed by these facts. Legendary investor Jeremy Grantham shared his thoughts earlier this week.
“Everything is uncertain, perhaps to a unique degree,” Granthan wrote in an investor letter. “The market’s P/E level typically reflects current conditions. Markets have historically loved fat margins, low inflation, stability and, by inference, low levels of uncertainty. This is apparently one of the most impressive mismatches in history.”
Following the market crash, there are several reliable stock picks that can weather another storm. But buying into a leveraged bet on the economy through Royal Bank of Canada shares seems borderline reckless.
