Wednesday, February 28, 2007

Banks, Refuge from Roiled Stock Markets?

The Financial Post, Sean Silcoff, 28 February 2007

When markets go into crash mode, as they did yesterday, it usually pays to take a deep breath and ask, "OK, so what should I buy?"

That may take nerves of steel -- at the very least, it beats panicking -- but one sector always seems to pop up as the right answer to that question: Canadian banks. Keep an eye on them, but don't buy just yet. There could be some interesting bargains to come.

To be sure, bank stocks were hit yesterday: Five of the Big Six were down, by 0.3% (National Bank) to 2.9% (CIBC); only Bank of Montreal was up, by 0.6%.

The banks had been on a mini-run since Oct. 31, as billions of dollars drained out of the income trust market thanks to Finance Minister Jim Flaherty's Hallowe'en announcement. Those funds spilled into other investments offering good dividend yields.

But that pushed banks to levels that were too high -- the six bank stocks rose by an average 9.3% each -- leaving them with price-to-earnings and price-to-book-value ratios that were a bit too rich relative to their international peers.

Nick Majendie, chief portfolio manager with Canaccord Adams, for one, sold off some of the Canadian bank stocks in his portfolios.

Now, he's watching, and waiting: If the TSX sells off by 10% to 20%, as he expects, bank stocks will fall in tandem by 10% to 15%, he figures. If so, "I think there will be some great buys" among the banks. "But don't buy them today."

Consider this: Whether oil goes to US$20 a barrel or US$100, gold to US$400 an ounce or US$1,000, and long-term interest rates settle at 4% or 6%, Canadian bank profits will keep rising. "I don't think there's another sector in the TSX you can make that statement about," one bank analyst said. "If China corrects, and oil and gold and commodity prices go down, the least of your problems has to be your bank stocks."

For those of you thinking of selling your bank stocks now, a quick reminder: Canadian banks have an unbeatable franchise, stellar returns on equity and steadily growing profit and dividend payouts. Bank earnings rose from $13.6-billion for the Big Six in 2004 to $17.9-billion last year -- with the more stable parts of their business, such as retail banking and wealth-management, driving the bottom line.

Why do some Canadians hate the banks so much, and why is Mr. Flaherty after their ATM fees? Maybe it has to do with their latest round of record-breaking year-end results.

Their mutual fund businesses have been stealing customers from the independents, proving the controlled-distribution model is hard to beat. Even when they book big loan losses -- as they did during the telecom's nuclear winter earlier this decade -- and during market corrections the banks outperform the market. During the housing downturns in Calgary in the 1980s and Toronto in the 1990s, they did just fine.

Still not convinced? Ask yourself this question: Pick any Canadian bank and any gold company. If the market swoons, which one is likely to book higher profits two quarters from now?

Just don't rush to beat the RRSP deadline. The banks are still overvalued. But if the stock markets continue to roil, it might be time to make a deposit.