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Why investors should celebrate the oddly absent post-earnings bounce in Canadian bank stocks

Canada's biggest banks sailed past expectations with their latest quarterly financial results, but bank stocks have gone nowhere since the reporting season wrapped up last week.

But investors should celebrate the market's indifference: Ignored stocks make better buying opportunities, should be less susceptible to economic bumps ahead and are well-positioned for rallies.

The banks' fiscal first-quarter results certainly exceeded most expectations.

Canadian Imperial Bank of Commerce kicked off the banks' reporting season on Feb. 22, with a profit of $3.18 a share, after making some adjustments related to U.S. tax reform and transaction costs stemming from its US$5-billion takeover of Chicago-based PrivateBancorp last June.

CIBC's adjusted profit was more than 12 per cent above the consensus estimate from analysts and was more than 10 per cent above last year's results.

The banks that followed also delivered impressive financial results, contributing to a quarter that made the Big Six banks look attractive on just about every level.

Profit? Over all, the Big Six banks reported that their adjusted profit rose by an average of 10 per cent from the fiscal first quarter of 2017 and beat expectations by an average of 5.8 per cent, according to Doug Young, an analyst at Desjardins Securities.

Sure, there were some nice surprises from business lines that tend to be volatile from quarter to quarter, such as capital markets.

But even profit from the bread-and-butter business of personal and commercial (P&C) banking – lines of credit, mortgages, credit cards and small-business loans – increased an impressive 12 per cent over last year.

Dividends? Four of the Big Six announced increases to their quarterly payouts, raising them by an average of 5.3 per cent. The average dividend yield is now more than 3.9 per cent.

Loan losses? The banks' provisions for credit losses, or money set aside to cover bad loans, remained very low at just 0.28 per cent – implying that consumers and businesses are meeting their obligations.

International operations? Banks with U.S. divisions reported an 18-per-cent increase in P&C profit over last year, driven by loan growth, expanding interest margins and contained expenses.

Bank of Nova Scotia, which has significant operations in Mexico, Colombia, Peru and Chile, reported a 14-per-cent increase in profit from its international banking division.

Add it up, and it's difficult to see why an investor would see problems in these results.

Yet, the market has responded with a collective shrug: Bank stocks are relatively unchanged since the start of the reporting season. Why?

The broader market has been struggling as inflation pressures build and investors anticipate additional rate hikes by the U.S. Federal Reserve, which could put a brake on economic activity and make loans more expensive.

It doesn't help stocks when U.S. President Donald Trump declares that global trade wars are good and then loses his top economic adviser, Gary Cohn.

But Canadian bank stocks are also reflecting home-grown threats. The dominant one: Changes to mortgage regulations have fed uncertainty about the country's housing market, casting a big unknown over mortgage underwriting at a time when Canadians are deep in debt.

In other words, investors might have appreciated the banks' first-quarter results, but they're wary of what's coming.

This is good.

The absent exuberance is keeping bank stocks reasonably priced. According to a report last week from RBC Dominion Securities, Big Six bank stocks trade at 10.9 times estimated profit for fiscal 2018. That's in line with the 10-year average multiple of 11.

New investors, or anyone adding to existing positions, can buy shares that aren't expensive.

More importantly, bank stocks aren't priced for perfection: Since concerns about trade wars and slowing mortgage growth are already reflected in the share prices, then one of two scenarios should play out over the next 12 months.

If the business environment deteriorates for Canadian banks, then reasonable valuations (and attractive dividend yields) should protect the stocks from a severe downturn.

And if the market's concerns are misplaced and banks continue to report rising profits from a stable housing market, rising interest margins and U.S. tax reform?

Then, there is plenty of room for the share prices to rise.

Full disclosure: The author owns an ETF that holds all Big Six bank stocks.

An  overview of the Big Six banks

BankReported profit/shareAdjusted profit/shareAdj. profit v. consensusAdj. profit change, yoy
RBC$2.01 $2.14 7.60%14.30%
TD$1.24 $1.56 6.70%16.80%
Scotia$1.86 $1.73 2.80%9.10%
BMO$1.43 $2.09 1.40%0.50%
CIBC$2.95 $3.18 12.50%10.10%
National$1.46 $1.47 3.60%8.80%

Desjardins Capital Markets, company reports

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