Over the last year, the performance of Canadian bank stocks has been mostly good despite the many macro-economic concerns. This speaks to the financial strength of the Canadian banking system, as well as the optimism in the market.
But what should we do about Canadian bank stocks now?
Canadian bank stocks remain a core holding
I think it’s important to remind ourselves that bank stocks are an integral part of a well-diversified portfolio. They have been core holdings providing shareholders with reliable income and long-term capital gains. Best of all, they have been highly resilient, weathering many storms that have come their way over the last many years.
With this being said, let’s take a look at where we stand now in order to decide on our next move.
Interest rates
As we know, interest rates are on their way back down again after rising rapidly to 5% in 2023. Today, the policy interest rate stands at 4.25%, with many analysts calling for a 50-basis point reduction at the next meeting. This reduction in rates is happening as inflation rates have come down to target levels and consumers are feeling the pressure as the cost of living has risen significantly.
So, on the one hand, lower interest rates are bad for the banks because they reduce net interest income. On the other hand, lower interest rates are supportive of the Canadian consumer, who is heavily indebted. This will allow for fewer delinquencies, bankruptcies, and defaults on loans, which is obviously good for the banks.
All in all, the positive of lower interest rates outweighs the negatives for the banks at this time.
Household debt
Another important consideration when considering the Canadian banks is the debt levels of Canadian households. Household debt increased 0.3% in August to $3 trillion, with consumer debt at the highest level in almost 20 years.
The lender at the opposite end of this equation is usually one of the Canadian banks. While they generally have tough underwriting standards, we have seen that they are preparing for credit losses to come. This will weigh on the banks when this happens.
Credit losses
Toronto-Dominion Bank (TSX:TD) has had many problems related to its ties to money laundering, which has been a distraction. But even this once untouchable bank is feeling the pressure. In its latest quarter, its provisions for credit losses (PCLs) soared 40% to just over $1 billion. This trend is consistent with all Canadian banks today and it represents a real risk to bank stocks.
Bank stocks rallying strong
With the exception of TD Bank, bank stocks have been performing very well over the last few years despite mounting macro-economic concerns. TD Bank stock has had its own company-specific problems with money-laundering and fraudulent practices. Its stock has been hit due to this. The bank has settled the issues, paid out its fines, and as the dust settles, we might find that we can actually buy it on the cheap for strong long-term gains. For now, however, it’s understandably been an underperformer.
The bottom line
As a group, the banks have continued to be resilient in the face of the latest macro-economic threats. In turn, Canadian bank stocks have generally also performed quite well over the last few years. Looking ahead, caution is warranted. I would generally not add to my positions at this time.
