Bank of Nova Scotia (TSX:BNS) remains out of favour, even as its peers are enjoying a nice rebound off their 12-month lows. Contrarian investors are wondering if BNS stock is now undervalued and good to buy for a self-directed Tax-Free Savings Account (TFSA) or Registered Retirement Savings Plan (RRSP).
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Economic outlook
Economists are broadly calling for a soft landing for the Canadian and American economies, as the central banks in the two countries battle to get inflation back down to their 2% targets. Inflation in Canada was 2.8% in June and 3% in the U.S., so there appears to be some progress.
Part of the drop can be attributed to much lower energy prices. West Texas Intermediate (WTI) oil spent June below US$75 this year compared to above US$100 in June 2022. The rebound in oil prices over the past few weeks, however, could alter the mood in the next couple of months. At the time of writing, WTI oil is back to US$82 for the first time since early April.
The resiliency of the American and Canadian economies in the face of sharp interest rates hikes over the past 12 months surprised most analysts. Unemployment remains near record lows, although job postings are declining. High immigration and the tight labour market are likely combining to keep the Canadian housing market from going into a tailspin.
It is probably too soon, though, to say a severe recession will be avoided. According to economists, rate hikes tend to take 12-18 months to work through the economy. Savings built up during the pandemic are helping households battle through higher living costs and rising debt expenses, but those buffers will eventually run out.
Should you buy Bank of Nova Scotia now?
A soft landing is certainly possible, and if that turns out to be the case, Bank of Nova Scotia is probably heavily oversold today. The stock trades below $66.50 at the time of writing compared to more than $81 in the middle of August last year.
At the current price, investors can pick up a solid 6.4% dividend yield and wait for the recovery.
Bank of Nova Scotia finished the fiscal second quarter (Q2) 2023 with a common equity tier-one (CET1) ratio above 12%, so the bank has adequate capital to ride out some tough times. New CET1 requirements from the Canadian bank regulator will bump the minimum ratio up to 11.5% before the end of the year.
Bank of Nova Scotia’s profits remain robust, and the board raised the dividend by nearly 3% when the bank announced the Q2 results, so there appears to be confidence among management that the outlook is solid for revenue and profits in the coming quarters.
A new chief executive officer took charge earlier this year. That normally means a shake-up is on the way. Bank of Nova Scotia could decide to sell parts of its Latin American operations to invest in new markets. The bank’s share price has underperformed Canadian peers that have focused on growth in the United States.
Additional volatility should be expected, but buy-and-hold investors might want to start nibbling while BNS stock is out of favour.
