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U.S. bank stocks have been outperforming their Canadian counterparts by a significant margin lately, and the relative moves in the currencies have only made Canadian bank stocks look even worse by comparison. Is it too late to switch from Canadian bank stocks to U.S.?
Before adjusting for currency, the S&P 500 Bank Index has outperformed the S&P/TSX Bank Index by 32 per cent since the beginning of 2012. For the period as a whole, the Canadian currency actually rose against the U.S. dollar. so after adjusting for currency changes, the U.S. outperformance since 2012 was 26 per cent.
For Canadian investors, the rise of the U.S. dollar has added 3.5 per cent to the return from U.S. bank stocks so far in 2013. Domestic banks have inched higher by three per cent while U.S. banks, if we include dollar gains, rose 18.6 per cent.
Three factors will likely determine whether the outperformance of American banks will continue: the economic environment of the respective countries; currency levels; and stock valuations.
In terms of the environment, both countries are struggling for economic growth, although our domestic economy appears to be deteriorating while the U.S. economy treads water. Importantly, the U.S. mortgage market – a major source of profits for banks – has a lot of room for recovery. The Canadian mortgage business, by contrast, is slowing.
Predicting currency changes is a mug's game. (Just ask gold investors.) The Canadian dollar level will depend a lot on China and commodity levels, which are difficult to predict at the moment.
Current valuation levels are not conclusive, but the evidence leans in favour of U.S. banks. The price to earnings ratios are roughly similar, and U.S. bank stocks are trading at a reasonably significant discount to Canadian financials.
All things considered, Canadian investors should consider adding positions in U.S. bank stocks, even if the buys need to be funded by reducing Canadian bank exposure. Faith in U.S bank stocks is returning, just as more questions are being asked about Canada's economy, housing market and – as retiring OFSI chief Julie Dickson highlights – bank credit risk.
Scott Barlow is a contributor to ROB Insight, the business commentary service available to Globe Unlimited subscribers. Click here to read more of his Insights, and follow Scott on Twitter at @SBarlow_ROB.
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Scott Barlow