07 August 2018

Why 2017′s Top TSX Stock Picker Says It’s Time to Avoid the Bank Sector

The Globe and Mail, Tim Shufelt, 7 August 2018

There are times when Canadian bank stocks trade more or less in unison, making it difficult to pick the winners from among the group. Last year was not one of those times.

With the oil market still trying to reconcile a global oversupply, the spring of 2017 saw the near-collapse of alternative mortgage lender Home Capital Group, bringing renewed scrutiny upon the Canadian housing market and, by extension, the banks.

“Those twin catalysts ended up creating an opportunity that frankly doesn’t always present itself in the banks,” said Robert Sedran, a bank analyst at CIBC World Markets.

Fast forward to now, and the analyst is waiting for the next jolt to the market to create some separation in the pack. “This isn’t the point of the cycle where we’d advise investors to jump into the sector aggressively,” he said.

Mr. Sedran’s keen timing earned him the distinction of being last year's top Canadian stock picker, as conferred by the Thomson Reuters StarMine Analyst Awards.

The awards rate sell-side equity analysts based on their investment recommendations for the companies they cover.

Each analyst's ratings are compiled to create a hypothetical portfolio. Performance is measured by the return that portfolio would have earned if an investor had followed the analyst's "buy" and "sell" recommendations.

Mr. Sedran’s picks would have generated an excess return of 16 per cent over the industry benchmark in the 2017 calendar year.

He credits most of that outperformance to calling the bottom on Canadian Western Bank.

In April, 2017, concerns about mortgage fraud among Home Capital’s network of brokers caused a run on the bank’s deposits and provided new fodder for Canadian housing bears.

“International investors were looking at the Canadian housing market and wondering if this was the match that finally lit the fuse. We felt strongly that it was not,” Mr. Sedran said.

One of the indirect casualties of the Home Capital debacle was Canadian Western, which was already being targeted for having considerable exposure to the energy sector. With Canadian Western shares down by 24 per cent over the previous six months, he slapped a buy on the stock in early June, 2017, just in time to catch a move upward in excess of 65 per cent over the next several months.

“A gain like that in a bank stock doesn’t happen very often,” Mr. Sedran said.

Canadian banks in general remain resilient to the slowdown in housing, which Mr. Sedran credits to the strength of the broader economy.

Though demand has fallen back as rates have risen and mortgage regulations have tightened, sellers are not generally motivated to accept lower prices as long as the economy is growing and unemployment is low.

“So there’s a decline in volume and perhaps the beginning of that fabled soft landing,” he said.

And though mortgage growth has slowed, the banks have enjoyed a built-in offset from rising rates, which help to improve profit margins.

“We think the profit trajectory for the banks is a pretty good one, at least until the next recession,” Mr. Sedran said.

The two names he expects to post above-average earnings growth over the next year are Toronto-Dominion Bank and Bank of Nova Scotia. Investing for superior earnings might be a better bet than looking for the group to benefit from multiple expansion, he said.

“We think we are late-cycle,” he said. “Now is the time to be a little bit more patient and cautious and wait for one of those dislocations.”