Morgan Stanley has slashed its price targets for U.S. bank and consumer finance stocks. So, like most Canadian investors, my immediate thought was whether the domestic banks would be subject to downgrades too. The answer is probably, but not to the same extent.
Morgan Stanley analyst Betsy Graseck cut her price targets on U.S. banks by 15 per cent on average in a 88-page research report on Tuesday. The analyst found that rising recession risks were only 37 per cent factored into sector stock prices. Morgan Stanley economists believe a U.S. recession is far more probable than that. Ms. Graseck also lowered her 2023 profit estimates by an average of 7 per cent.
The fate of Canadian bank stocks in an environment of recessionary fears was tackled directly by Scotiabank analyst Meny Grauman in July 8th’s 50 Shades of Grey: Why Not All Recessions Are Created Equal and What That Means For Bank Stocks.
Mr. Grauman succinctly summarized his view: “While we believe that investors need to be braced for a material slowing in banks’ revenue growth, a dramatic deterioration in credit … is highly unlikely.” As a result, the average return on his outperform-rated bank stocks is an encouraging 33 per cent.
The analyst’s continued bullishness is predicated on the belief that any Canadian recession would be a shallow one. This is because labour markets remain strong, unemployment low, and thus general household finances are robust enough to prevent widespread credit write-offs despite high debt levels.
Valuations for the domestic banks remain attractive. The forward price to earnings ratio of 9.7 times is well below the 20-year average of 11.7 times. Current levels are not far off the pandemic low of 9.2 times. For further context, the financial crisis low was 8.0 in January 2009.
Wednesday’s surprise one percentage point rate hike is another hurdle for bank stocks. By flattening the yield curve, it makes the core business of borrowing funds at short term rates and lending them to clients at (usually higher) long-term rates less profitable. History tells us, however, that there are few bad times to buy domestic bank stocks and unless it truly is different this time, losses in the sector should remain contained
-- Scott Barlow, Globe and Mail market strategist
Also see:
Recession fears outweigh the lure of cheap U.S. bank stocks
This is the Globe Investor newsletter, published three times each week. If someone has forwarded this e-mail newsletter to you or you’re reading this on the web, you can sign up for the newsletter and others on our newsletter signup page.
Stocks to ponder
Surge Energy Inc. (SGY-T) Year-to-date, Surge is the top performing energy stock in the S&P/TSX Small-Cap Energy Sector with a gain of 88 per cent as of the close on July 11. Can its winning streak continue? Jennifer Dowty looks at the investment case.
The Rundown
Why utility stocks, which normally suffer during rate hikes, are some of the TSX’s top performers
Unlike other high-yielding stocks such as telecoms and real estate investment trusts, shares of Canadian utilities have proved surprisingly resilient even though rates are rising. David Milstead explains why.
Three Canadian stock picks from top-rated analysts
How to find good companies to invest in? One way is with the help of the brokerage analysts whose stock picks have performed well enough to earn a five-star ranking by the tipranks website. Larry MacDonald went looking for five-star analysts and their recent Canadian stock picks to get some investment ideas.
Others (for subscribers)
David Rosenberg: Housing is set for a monstrous fall-off and the Bank of Canada is underestimating the economic risks
Bruised investors seek shelter in U.S. health care stocks
Volatile U.S. markets boost appeal of dividend stocks
Wednesday’s analyst upgrades and downgrades
Tuesday’s analyst upgrades and downgrades
Tuesday’s Insider Report: Director is a buyer of this stock yielding over 8%
Globe Advisor
Direct indexing offers portfolio customization but cost is part of why it hasn’t taken off in Canada
Are you a financial advisor? Register for Globe Advisor (www.globeadvisor.com) for free daily and weekly newsletters, in-depth industry coverage and analysis, and access to ProStation - a powerful tool to help you manage your clients’’ portfolios.
Ask Globe Investor
Question: I have always wondered why John Heinzl’s model Yield Hog Dividend Growth Portfolio has no oil and gas producers, which pay higher dividends than some of the other stocks in the portfolio. Why don’t you own these stocks?
Answer: I chose not to include oil and gas stocks – or resource producers of any kind – for one reason: Their earnings are closely tied to commodity prices that are beyond their control. This makes their dividends unstable and unpredictable.
I learned this lesson the hard way years ago when, straying from my core strategy of focusing on long-term dividend growth, I purchased shares of Crescent Point Energy Corp. in my personal portfolio. At the time, Crescent Point was paying $2.76 in dividends annually and yielding more than 7 per cent.
When oil prices tumbled, however, the company slashed its dividend by more than half in 2015. Several more dividend cuts followed. Predictably, the stock price collapsed.
That was enough oil and gas for me. Now, the only energy stocks I own personally and in my model portfolio are pipelines, whose fortunes are largely insulated from the price of the commodities they transport.
Granted, in recent months I’ve missed out by not owning energy producers, as the sector has rallied on rising commodity prices. Oil and gas companies are once again raising their dividends – Crescent Point hiked its payout by 23 per cent this week, for its fourth increase in less than a year – and analysts remain bullish on the sector, even as crude oil prices have slipped from their recent highs.
But even if it means leaving a few bucks on the table now, I’m happy to stick with companies whose dividends are more stable and predictable than the payouts from resource producers. The next time energy stocks head south, I won’t lose any sleep.
--John Heinzl
What’s up in the days ahead
Stocks are steadying after falling into a bear market in the U.S. So is this the time to start tip-toeing in and picking up some long-term buys? Tim Shufelt and Ian McGugan will be sharing some insight.
Click here to see the Globe Investor earnings and economic news calendar.
More Globe Investor coverage
Getting into investing? Earn a $25 gift card to participate in our research study. We’d like to talk with people who are between the ages of 25-40 who consider themselves a beginner or intermediate investor. Sign up here, and our UX Lab will contact you by email.
Compiled by Globe Investor Staff