A potential interest rate cut from the Bank of Canada could benefit Canadian bank stocks, says one portfolio manager, but if rates stay where they are those same stocks will face headwinds.
Colin White, president and CEO of Verecan Capital Management, said in an interview with BNNBloomberg.ca last week that Canadian bank stocks trade as a “proxy for the Canadian economy.” He said that the impact of interest rates is less about the direct impact on the group of lenders and more about the impact on the overall economy.
“If we see the interest rates drop and that alleviates some of the pressure on defaults, that will be positive for them. It will also indicate they are trying to stimulate the economy, which will also be good for them,” White said.
“If interest rates stay where they are, I think they’re going to have a bit of a headwind because those defaults are going to stay where they are or perhaps ramp up. And the economy is not necessarily going to be going gangbusters in that environment.”
Amid higher interest rates all of Canada’s major lenders have moved to increase loan loss provisions, White said, including for loans currently in good standing.
“So the longer interest rates stay higher, the more pain that's going to be and more defaults we are going to see. So there is a time aspect to this as well,” he said.
In the first quarter, all of Canada’s Big 6 banks allocated more capital to cover bad loans compared to the previous year. The move was a sign that the lenders were wary of the economic health of clients.
In total Canada’s Big 6 banks put aside over $4 billion in loan loss provisions during the first quarter. White said the current loan loss ratios “may not be material in the bigger scheme of things,” but rather a sign of overall economic performance.
White said loan loss provision figures will be something to look for when Canada’s major banks report second-quarter results.
“It's difficult to quantify how much debt they have that's coming due in the next six months or next nine months and I think that loan loss provision numbers is going to be a bit of a window into that. And also will go into how fast they need to see rates begin to move in order to protect themselves from future write-downs,” he said.
Expected rate path
The Bank of Canada elected to hold interest rates at five per cent Wednesday, in line with unanimous expectations among economists tracked by Bloomberg. However, five of the 13 economists are anticipating a rate hold at the Bank of Canada’s June 5 meeting, with the others expecting a 25 basis point interest rate cut.
Notably last week, Bloomberg News reported that CIBC Chief Executive Officer Victor Dodig said he doesn’t anticipate a series of rate cuts this year.
“I’ve never been of the view that there’ll be multiple cuts this year,” Dodig said during the bank’s annual general meeting.
When looking at the most current economic figures, White said he doesn’t see rate cuts coming soon.
“There is another reality people aren’t talking about as much, (but) maybe this is where interest rates belong. This could be the new reality, this could be the level of interest that we need to keep inflation under control,” he said.
First quarter results
Canada’s Big 6 lenders saw mostly strong results in the first quarter, with most beating expectations. However, Bank of Montreal missed revenue and earnings per share (EPS) expectations.
“Canadian banks are good businesses and they're going to put up solid numbers,” White said.
“They always are challenged with hitting growth, because most of them to one degree or another have diversified outside of Canada and search for continued growth because they control the market here in Canada.”
With files from Bloomberg News.
FAQs
One sector that tends to benefit the most is the financial industry. Banks, brokerages, mortgage companies, and insurance companies' earnings often increase—as interest rates move higher—because they can charge more for lending.
Will stocks go up when interest rates go down? ›
In other words, the market's anticipation that the Fed would lower rates had a positive effect stock prices, since it assumes that a company's earnings per share and profits will rise as borrowing costs decline. In effect, lower interest rates lead to higher price-to-earnings metrics and vice versa.
How do bank stocks react in a recession? ›
Bank stocks typically underperform heading into a recession. They act as a proxy for the health of the economy. If the market is looking 18 months into the future, they expect a slowdown in activity from the banks. However, once we're in a recession, banks typically outperform.
What factor can cause bank stock price to drop? ›
In a broad sense, a bank's share price is affected by the same forces that affect the share prices of other public companies. Major, abstract factors can impact a bank's share price. These include overall market sentiment, expectations about the future, fundamental valuation, and the demand for banking services.
What will make bank stocks go up? ›
While higher interest rates may benefit banks by allowing them to charge more for loans, higher borrowing costs put a damper on transactions, McGratty said. A cut in interest rates may stimulate more economic activity, which will benefit banks, he said.
What stocks do well when interest rates fall? ›
The consumer discretionary, technology, real estate, and financial sectors have historically been especially likely to outperform the market when rates fall and earnings rise. Financial stocks look particularly appealing, due to how inexpensive they've recently been.
What is the stock market prediction for 2024? ›
The Big Money bulls forecast that the Dow Jones Industrial Average will end 2024 at about 41,231, 9% higher than current levels. Market optimists had a mean forecast of 5461 for the S&P 500 and 17,143 for the Nasdaq Composite —up 9% and 10%, respectively, from where the indexes were trading on May 1.
Are lower interest rates good for equities? ›
Since the 1960s, there have been 85 easing cycles in G10 economies. This means that past experience gives us a good idea about what generally happens to markets when rates are cut. In theory, lower interest rates should be good news for equities. Falling rates boost the economy, providing a boost to earnings, too.
Should you sell bonds when interest rates rise? ›
If bond yields rise, existing bonds lose value. The change in bond values only relates to a bond's price on the open market, meaning if the bond is sold before maturity, the seller will obtain a higher or lower price for the bond compared to its face value, depending on current interest rates.
What stocks do worst in a recession? ›
Equity Sectors
On the negative side, energy and infrastructure stocks have been the hardest-hit in recent recessions. Companies in these sectors are acutely sensitive to swings in demand. Financials stocks also can suffer during recessions because of a rising default rate and shrinking net interest margins.
The expectation right now is that a mix of competing factors will ultimately equate to modest revenue growth in 2024, while profit per share of the ETF is expected to drop just over 4% to $4.67 next year. Analysts expect 2.1% sales growth for the bank ETF.
What is the best stock to buy in a recession? ›
Historically, consumer staples, health care and utilities stocks tend to weather recessions better than other sectors.
Why bank stocks are plummeting? ›
Banks have broadly struggled under the weight of higher interest rates, but midsize and smaller institutions have been hit particularly hard. The decline comes just ahead of bank earnings season, which the megabanks kick off on Friday.
Why did banks lose their money when the stock market crashed? ›
Many smaller banks, such as this one in Haverhill, Iowa, lacked sufficient reserves to stay in business and became no more than convenient billboards. Many of the small banks had lent large portions of their assets for stock market speculation and were virtually put out of business overnight when the market crashed.
What drives bank stocks? ›
What Drives Banks' Share Prices? Bank shares are impacted by broad economic factors, including interest rates, inflation, overall productivity and growth, and general market sentiment—especially as it applies to housing.
Why are banks' stocks falling? ›
IT stocks closed lower amid concerns over tighter-for-longer US monetary policy. Sensex settled at 75,410.39 while broader NSE Nifty ended a...
Will US bank stock go up? ›
USB Stock 12 Month Forecast
Based on 17 Wall Street analysts offering 12 month price targets for US Bancorp in the last 3 months. The average price target is $46.43 with a high forecast of $54.00 and a low forecast of $42.00. The average price target represents a 12.07% change from the last price of $41.43.
How does the Fed interest rate affect banks? ›
Key Takeaways. The Fed sets target interest rates at which banks lend to each other overnight in order to maintain reserve requirements—this is known as the fed funds rate. The Fed also sets the discount rate, the interest rate at which banks can borrow directly from the central bank.
Do banks do well during inflation? ›
Inflation allows borrowers to pay lenders back with money worth less than when it was originally borrowed, which benefits borrowers. When inflation causes higher prices, the demand for credit increases, raising interest rates, which benefits lenders.
