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Could Bank Stocks Be Due for Another 2020-Type Scenario?

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The idea that bank stocks could go through another cycle down isn’t a crazy idea. Indeed, bank stocks are among the most cyclical plays in the market for good reason.

When the economy is booming, lending activity accelerates. Folks borrow and spend. And banks do very well, paying out impressive dividends to investors.

However, in a recession-type scenario, everything grinds to a halt. Accordingly, investors worried about the implications of the economic damage to businesses tend to reflect their sentiment in bank stocks early.

This year, Royal Bank of Canada (TSX:RY)(NYSE:RY) has surged approximately 25% on rather bullish sentiment. Indeed, it appears investors are pricing in some good days ahead.

That said, being the Foolish investors we are, it’s important to consider the risks. Let’s dive into what could be in store for bank stocks from here.

Bank stocks drop on Liberals’ promise

The Canadian election happens to be a bigger deal for bank stocks than for most other stocks right now.

Why?

Well, the Liberal Party just announced a plan to increase corporate taxes on banks to help pay for all the spending. The corporate tax rate big banks pay would be hiked to 18% from the 15% rate currently. Additionally, other indirect forms of taxation on big banks are being discussed.

Of course, any sort of increase to a given sector’s tax rate has negative implications for valuations. Accordingly, Royal Bank’s stock price has been overly volatile in recent days.

Indeed, there are a lot of potential outcomes as a result of the election. The Liberals could (likely) take a minority government, though a surprise win from the Conservatives is on the table. Should a Liberal majority be achieved, investors may be more worried.

That said, it appears (at least right now) that’s unlikely. Accordingly, Royal Bank stock has been little changed over the past five days.

How strong is the economic recovery, really?

This question of the strength of this pandemic recovery is a big one.

For Canadian bank stocks, it’s perhaps more prescient. As mentioned, this sector is particularly economically sensitive. What ultimately unfolds in the months and years to come will impact bank stocks disproportionately.

For those bullish on continued growth in the Canadian economy, there’s likely nothing to fear. Royal Bank is one of the best options in this sector. It pays a great dividend and has extremely stable, growing cash flows.

Bottom line

Indeed, Royal Bank remains one of the most stable long-term bank stocks investors can consider. Indeed, this is the largest Canadian bank for a reason. Royal Bank has a stellar reputation globally and is likely to continue to perform well over the long term.

However, there are risks to buying bank stocks right now. Investors need to make informed decisions and may want to think about where they see the economy going in five or 10 years from now before jumping into any stock, for that matter.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Chris MacDonald has no position in any of the stocks mentioned.

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