Despite reasonable valuation levels, attractive dividends and a recently-completed earnings season with uniformly strong profit reports, domestic banks stocks have barely budged. Year to date, the S&P/TSX Bank index has a total return of only 0.68 per cent, trailing the composite index by more than four percentage points.
An increasingly tapped out domestic consumer could lie behind the banks' sluggish recent performance. Over the long term, the value of domestic bank stocks tends to follow the trend of consumer debt. Banks earn profits on loans, so more consumer debt means higher bank profits.
Canada consumer debt vs S&P/TSX Bank index
SOURCE: Scott Barlow/Bloomberg
The total amount of household debt remains alarmingly high, at more than 160 per cent of disposable income, but the pace of new consumer loans has slowed markedly. Debt growth grew annually at an average of 11 per cent in the five years before the financial crisis. In the past year, however, consumer loans have increased at only 2.1 per cent.
Bank profits are fine for now, but the market appears to be looking ahead with a more skeptical eye.
Current household debt levels are almost certainly unsustainable – they are already above the pre-crisis peak for U.S. households.
The anemic consumer loan growth levels of the past year are a precursor to a prolonged period of deleveraging when total debt not only stops growing, but declines. Loans are the primary assets on bank balance sheets, so lower total debt levels implies declining book values for the major banks.
The domestic banks are so huge and so diversified that insurance and other businesses will be able to offset the negative effects of a deleveraging consumer. But it's also likely that the rapid consumer-driven profit growth of the recent past has come to a close.