Debating a portfolio’s market-appropriate exposure to stocks like BMO is a popular pursuit for pundits. However, things could get nasty and fast for the nation’s top moneylenders. Banks will bear the brunt of an economic slowdown, with loan defaulting, lower oil, and grim quarterly reports also amassing on the horizon. Let’s break down a few reasons why now might be a better time to trim, rather than grow, a position.
Loans are about to turn toxic
Cast your mind back to last year. Household debt was high and a credit bubble was inflating. A Canadian banking crisis was being whispered about, even when times were good. Now fast-forward to the pandemic, and all of the additional problems brought by it. Household debt-servicing could be about to flip over into emergency mode. In short, loan servicing could be put on the back-burner en masse as the economy slows.
Investors seeking a metric that illustrates this danger should consider Canada’s household debt to disposable income ratio. In 2017, this ratio was 171%. Now it’s 176.9%. In other words, for every dollar Canadians have available to spend, we now owe $1.77. And this statistic reflects the first quarter – at the start of the pandemic. Odds are that this key metric has inched even higher during the health crisis.
Bank stocks are dangerously exposed to lower oil
The year 2020 has been a disastrous one for oil and gas companies, with prices in the black gold turning briefly negative in April. It’s no secret that oil producers owe the banks money. What is perhaps less well known is just how much money: Big Six energy loans were up by a considerable 23% in the second quarter. This might make Canadian banks higher-risk investments than some investors are comfortable with.
Trimming names like CNQ? Given the strong connection between banks and oil producers, investors should ask whether they need any extra exposure to the latter in their portfolios. Both banks and hydrocarbon fuel companies have seen heavy losses on the TSX year-on-year. Their performances could continue to see unnerving correlations as the current market develops and evolves.
Earnings are likely to disappoint
Couple the above with what is likely to be a round of disappointing, if not disastrous, earnings reports and investors have a pretty weak thesis for buying shares in the Big Five/Six. Instead, bullish TSX investors should trim these names from their portfolios with a view to potentially buying them back at much lower valuations. With a possible second painful correction yet to hit equities this year, a fire sale could very well be on the way.
The solution to all of this? Raise cash and put more money into safe havens. If this means trimming some risky assets from an equities portfolio, banks could make an appropriately soft target. On the flip side, gold producers are likely to see their gains extended as volatility comes back to roost in the latter half of the year.
Right now, though, investors should take advantage of a buoyant market to trim risk and increase liquidity.
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Fool contributor Victoria Hetherington has no position in any of the stocks mentioned.