14 May 2006

Banks Lose Out to Red Hot Commodities

Reuters, 14 May 2006

In a market hooked on red-hot commodities, Canada's financial stocks are flat this year, and even predictions of positive earnings from the sector aren't pulling investors away from their thirst for oil and lust for gold.

"Insurance company earnings will probably be higher than the banks', if the banks are high single digits (earnings growth), the insurance companies might be low double digits," said John Kinsey, a portfolio manager with Caldwell Securities Ltd.

He forecast dividend increases, share buy-backs and stock splits when the banks report second-quarter earnings in the coming weeks, announcements that would be enough to boost the sector under normal market conditions.

But the likelihood of good news in the sector is not inspiring investors this time, as soaring commodity markets grab everyone's attention and suck in capital from bigger and more liquid sectors like insurance and banks.

"There is a situation of group rotation that takes place from time to time and, in part, that's what's happening," said Michael Goldberg at Desjardins Securities. "Bank stocks are being used as a source of funds to buy other stuff."

Lifted by record crude prices, Canada's oil and gas sector is up 10 percent so far this year, while the mining-focused materials sector is ahead 26 percent. The gold sector, a component of the materials group, is up a staggering 35 percent.

The rise in commodity-focused stocks also reflects gold prices at 25-year highs, and firm prices for other metals.

Goldberg said financial stocks are often seen as a safe place to position money because they offer good returns from growth and steady dividend increases. But parking money is not the most exciting motivation to own stocks.

The Toronto Stock Exchange S&P/TSX composite index is up 6.9 percent this year. In contrast, the financial sector is up a lackluster 0.7 percent.

Adding to the financial sector's worries is the specter of rising interest rates, which increase the cost of borrowing for the banks.

The U.S. Federal Reserve raised rates a quarter of a percentage point to 5 percent on Wednesday and left the door open to further interest rate hikes.

The Bank of Canada is expected to raise its overnight interest rate to 4.25 percent on May 24, and some analysts expect it to signal its monetary tightening campaign will end, due in part to the Canadian dollar's strength.

But analysts say higher interest rates are not damaging banks as they once did, as banks look to other sources of income such as underwriting and fees.

They say it may not yet be time for investors to return to the sector. Financial stocks are still 76 percent above the levels seen at the start of 2003 -- a performance that compares unfavorably with an 82 percent rise in the overall index.

"There is so much volatility in this market that they tend to go too far on the upside and they tend to go too far on the downside," said Kinsey.