In an interest rate hike cycle to counter inflation, the Bank of Canada raised the policy interest rate by 4.25% over the last year. The central bank is now holding the policy interest rate steady at 4.50%, as it observes the impacts of higher interest rates rippling across and impacting the economy.
We’re likely at the peak of an interest rate hike cycle. Typically, the Bank of Canada raises the policy rate to counter inflation and lowers it in a recession to stimulate economic growth. Therefore, it’s only a matter of time before the central bank would enter a cycle of lowering interest rates.
Currently, economists anticipate a mild recession occurring in Canada this year. Some analysts project that interest rates could recede in 2024/25. If so, the economy could experience a growth spurt by 2025. One of the best Canadian stocks that could benefit is Toronto-Dominion Bank (TSX:TD).
In fact, because of the recent banking shakeup, including the collapse of Silicon Valley Bank and First Republic Bank, the TD stock price has evidently taken a beating. Recall that TD Bank owns a meaningful stake of about 12% in Charles Schwab, which is down approximately 39% year to date versus TD’s decline of roughly 8%.
For Canadian investors, TD stock is generally a lower-risk investment compared to investing in U.S. bank stocks. First, TD enjoys an oligopoly environment in Canada that’s well regulated. The Big Six Canadian banks together hold about 90% of the country’s deposits. Additionally, the regulation prevents any single shareholder from owning more than 20% of a Schedule I bank like TD. This also prevents foreign takeover.
Second, because of TD’s stake in Schwab, it currently trades at a discount that’s uncommon to come by. Along that line, therefore, it also offers a boosted dividend yield of 4.7%. How big of a discount does TD stock offer? At $81.12 per share at writing, it trades at a discount of close to 20% from its long-term normal valuation.
Third, unless you’re investing in your Registered Retirement Savings Plan/Registered Retirement Income Fund, you get a tax advantage from earning Canadian eligible dividends that TD stock pays out. In a non-registered account, you would enjoy the dividend tax credit. In a Tax-Free Savings Account or Registered Education Savings Plan, you would get the full dividend unlike U.S. dividend stocks that would have a foreign withholding tax on the dividends.
Investor takeaway
Inflation got out of hand. So, like other key central banks around the world, the Bank of Canada raised its policy interest rate to curb inflation. However, higher interest rates have also increased the cost of capital for businesses, families, and individuals.
Economists anticipate a mild recession this year. When the Bank of Canada finally lowers interest rates in a recession, all TSX stock valuations should experience a lift. If you have an investment horizon of at least three to five years, you should experience a market-beating total return from TD stock. In the meantime, you can earn nice dividend income from the top bank stock.
That said, if possible, you should spread your risk by investing in a diversified portfolio of solid dividend stocks and growth stocks.
