A TD sign on a post outside the TD Terrace building at Front St. West and Simcoe St. in Toronto’s Financial District on Mar 4.Fred Lum/The Globe and Mail
Why aren’t Canadian banks going up like the big U.S. banks? JPMorgan Chase & Co. JPM-M-N, for example, is up about 17 per cent this year, and Wells Fargo & Co. WFC-N has gained about 22 per cent. Canadian banks are either down or have single-digit gains. Why is this happening, and what will it take for Canadian banks to move higher?
I ran your question by Rob Wessel, a former top-ranked bank analyst who is now managing partner of Hamilton ETFs.
“Historically, the Canadian banks have been very strong investments relative to their U.S. large-cap peers. That said, the U.S. banks have meaningfully outperformed the Canadian bank peers recently,” Mr. Wessel said in an e-mail.
There are several reasons for this, he said. A year ago, U.S. banks were trading at lower valuations than the Canadian banks. But thanks to the resilient U.S. economy, U.S. banks have enjoyed stronger growth in earnings per share, driven by rising net interest income, solid loan growth and strong capital markets for the largest banks.
“By contrast, a sluggish Canadian economy has weighed on revenue growth for our banks and contributed to large and sustained increases in loan-loss reserves, making it difficult for the Canadian banks to grow earnings, which has weighed on their stocks. Taken together, this has produced a surprisingly large divergence in performance, which will be difficult for the U.S. banks to sustain,” he said.
Problems specific to individual Canadian banks have also weighed on their share prices. Toronto-Dominion Bank TD-T, in particular, has been slammed by allegations that drug traffickers exploited its lax anti-money-laundering controls in the U.S. to wash hundreds of millions of dollars in illicit profits, sparking investigations by the U.S. Department of Justice and financial regulators. Analysts estimate that TD could ultimately face penalties of about US$2-billion.
TD kicked off second-quarter earnings season for the banks on Thursday, posting adjusted net income of $3.79-billion that was up slightly from last year and ahead of analysts’ estimates. The rest of the Big Six banks will report this coming week.
According to Mr. Wessel, potential catalysts for Canadian bank stocks include stronger economic growth, more favourable capital markets and improved credit conditions.
“In our view, analyst estimates for credit losses for next year – 2025 – are quite conservative and include continued reserve builds, which is a big assumption given that total allowances for credit losses have risen for seven consecutive quarters and are currently approaching highs reached during the COVID-19 pandemic,” he said.
“This conservatism offers the potential for credit losses next year to be lower than expected, resulting in better-than-expected earnings and increased consensus earnings estimates for 2025. Lastly, the sector is not terribly expensive on forward earnings, with an average multiple of about 10.3 times 2025 estimates, and dividend yields, on average, are close to 5 per cent, providing some downside protection.”
I am semi-retired and my wife is still working. We try to maintain a roughly 60/40 split of stocks vs. fixed income. We have a handful of individual stocks but most of our equity position is in exchange-traded funds. About 12 per cent of our portfolio is in the Vanguard S&P 500 Index ETF VFV-T. Do you think it is risky to hold such a large position in one ETF? Should I diversify into more than one ETF for the U.S. portion of our portfolio?
I don’t think you need to sweat this too much. If you had 12 per cent of your portfolio in a single stock, that would qualify as risky. But having 12 per cent of your portfolio in a broadly-diversified ETF doesn’t raise any red flags for me.
The purpose of an index ETF, after all, is to provide diversification, and S&P 500 funds such as VFV do just that, and at very low cost (VFV’s management expense ratio is just 0.09 per cent). While technology shares account for nearly 30 per cent of the S&P 500, financials, health care and consumer discretionary stocks also have double-digit weightings, with high single-digit contributions from communications, industrials and consumer staples. So you’re getting a nice cross-section of the U.S. economy, which helps to control your risk.
You could achieve even greater U.S. diversification with a product such as the Vanguard U.S. Total Market Index ETF (VUN), which holds more than 3,700 U.S. stocks, compared with the 500 largest U.S. companies in the S&P 500. However, VUN and VFV have a great deal of overlap, particularly among their largest constituents, and consequently their returns have been very similar. For the 12 months ended April 30, VFV’s total return, including dividends, was about 24.3 per cent, compared with 24 per cent for VUN.
If anything, you could even increase your weighting in VFV by a few percentage points to get more U.S. exposure. Depending on your risk tolerance, you might also benefit from increasing your overall equity weighting to more than 60 per cent. Some investors have found that the 60-40 mix, which has been a popular rule of thumb for decades, is too conservative given that people are living longer and stocks have historically outperformed bonds. But if the 60-40 split helps you stay disciplined and lets you sleep at night, then by all means stick with it.
E-mail your questions to jheinzl@globeandmail.com. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.