Interest rates may rise yet again in Canada.
Following the U.S. Federal Reserve’s move to raise rates 25 basis points at its last meeting, Bank of Canada Governor Tiff Macklem hinted that he may have to raise rates again. Specifically, he said that if inflation remains “sticky” (an economics term meaning “persistent”) above 2%, he may have to do another hike or two.
For Canadian investors, it’s a scary prospect. Canadian stocks have done surprisingly well over the last year and a half, falling just 2.5% in a period in which U.S. stocks fell 11.5%. Partially, that was because Canadian markets have a lot of names that benefit from high interest rates (large banks) and those that weren’t particularly hurt by them last year (energy). It was a fortuitous set of circumstances, but it may not last. In this article, I will explore three stocks that should be fairly safe if rates rise – two Canadian, and one American.
TD Bank
The Toronto-Dominion Bank (TSX: TD) is Canada’s second-biggest bank by market capitalization. It’s a company that does a mix of lending, investment banking, and insurance, in both Canada and the United States.
You might be shocked to hear me say that “banks are safe” in this environment, after all the pandemonium that took place in U.S. banking in March and April. But remember that TD Bank is a large Canadian bank, not a small U.S. bank. Canada has regulations that prevent banks from taking on huge risks like the ones that sunk Silicon Valley Bank and the rest. For example, it has much higher minimum capital and liquidity ratios than the U.S. does. These regulations help prevent banks from taking on too many risks.
In the meantime, banks that don’t take too much risk can actually make money off of interest rate hikes. When central banks raise interest rates, banks raise the interest rates they charge on loans. That doesn’t always result in higher profit, but it worked out well for big U.S. banks last quarter: all of them posted large year-over-year increases in profit.
Royal Bank of Canada
The Royal Bank of Canada (TSX: RY) is another large bank like TD Bank. Much like TD Bank, RY has high capital ratios and liquidity ratios. Unlike TD Bank, its growth strategy appears quite likely to go ahead without a hitch. TD Bank recently had its biggest deal quashed by U.S. regulators. The deal was a bad one– TD was offering far too high a price. But the fact that the deal was shot down bodes poorly for TD’s future M&A activity in the United States. Royal Bank’s own deal to buy HSBC Canada is going smoothly so far, so perhaps RY has more growth engines than TD does. In either case, both stocks are worth owning.
Charles Schwab
Charles Schwab (NYSE: SCHW) is a U.S. brokerage and bank that stands out for its incredible liquidity and capitalization. Its CET1 ratio – which means high quality capital divided by risk-weighted assets – is 18.9%. Its liquid assets are enough to cover 94% of deposits. In the case of an extreme bank run, Charles Schwab would stand a fighting chance of surviving. In the meantime, as a brokerage, it can make money by investing client money in treasuries, which helped it grow its earnings 14% last quarter.
