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High-flying Canadian bank stocks ignore reality Add to ...

Something strange is going on among Canadian bank stocks: Despite growing concerns about the Canadian economy and loan growth in particular, bank stocks are on a tear.

Toronto-Dominion Bank has risen 10.4 per cent over the past year, after factoring in dividends, handily beating the 3 per cent return for the benchmark S&P/TSX composite index. And TD is a relative slouch among the Big Banks.

Bank of Montreal has risen 13.5 per cent, Canadian Imperial Bank of Commerce has risen 15 per cent and Royal Bank of Canada has risen 23.3 per cent.

Indeed, the average 52-week return for a Big Bank stands at 15.8 per cent – or more than five-times the return on the TSX. What’s more, TD, Scotia and Royal (full disclosure: I recently sold my Royal holdings and am feeling a bit bitter about missing out on the ongoing run-up) are close to record-highs.

Bloomberg News points out that Canadian banks are still recognized as the world’s strongest – at least by the World Economic Forum – but the title, bestowed on Canadian banks for five straight years, seems to ignore a deteriorating environment right now.

Consumers are struggling under record-high debts as the housing market cools and the overall economy shows signs of stumbling: Retail sales in December registered their largest decline in nearly three years. Last month, the Bank of Canada cuts its growth forecast in the fourth quarter to just 1 per cent, at an annualized pace.

Standard & Poor’s issued a note on Canadian banks on Friday, timed for the start of the fiscal first-quarter reporting season on Thursday. S&P sounds cautious: “In light of our expectations for weak economic growth prospects for Canada in 2013, we anticipate overall loan and revenue growth will slow due to softer demand for credit,” S&P credit analyst Thomas Connell said in a release.

Right now, S&P believes that bank credit ratings are stable – although that could change if “recessionary conditions return.” But even without such conditions, banks have their work cut out for them: the economic weakness coincides with new and restrictive regulations and rising competitive pressures.

S&P expects earnings will be hindered by tighter margins and higher loan-loss provisions.

Meanwhile, Bloomberg News noted that Canadian household debt has risen to 165 per cent of disposable income, a record high. At the same time, new home construction in January fell 19 per cent from the month before and growth of personal credit-card loans has retreated following stellar growth over the previous four years.

“A slowing economy risks exacerbating the already-intense competition between banks for loan and deposit share and puts further pressure on the margins and profitability of Canadian financial institutions’ retail and commercial lending businesses, the cornerstone of Canadian banking and the largest contributor to revenues,” S&P said in its report.

None of this bodes well for banks, where the consumer sector accounts for 70 per cent of total bank loans. You have to wonder how far this bank rally can go before reality catches up to share prices.

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