With earnings season pretty much wrapped up, the record highs that have eluded the Canadian stock market for six months may be starting to come into view.
As impressive as the rally in Canadian stocks has been over that time, there’s been one big missing piece. Or rather, six of them.
The Big Six, as Canada’s largest banks are known, have been mired by concerns over the economy and resulting credit losses, which has held back the S&P/TSX Composite Index from making that last leg upward to pre-pandemic levels.
“We expect financials will eventually participate in the recovery with much higher conviction than is currently priced in, and when it does, the TSX is likely to see strong outperformance and hit new all-time highs,” Brian Belski, chief investment strategist at BMO Nesbitt Burns, said in a note.
He revised his 2020 year-end target for the Canadian benchmark index to 18,200, just higher than the previous record of 17,944 set in mid-February, before the pandemic sent global and domestic equities into a tailspin.
“No doubt the uncertainty and chaos that COVID-19 impressed upon the world has shifted investor preferences, but as the market continues to pivot from chaos to coexist, we believe Canadian stocks will ultimately participate,” Mr. Belski said.
Since the low point in the sell-off was recorded on March 23, the S&P/TSX Composite Index has risen by 49 per cent – a monumental rebound, but still trailing U.S. stocks by a decent margin. The S&P 500 index is up by 56 per cent while the technology-heavy Nasdaq Composite Index has gained 70 per cent.
While the beleaguered energy sector has played a role in that underperformance, financial stocks, which comprise nearly 30 per cent of the TSX by market capitalization, are the main culprit.
Canada’s diversified bank stocks were hammered in the selloff, falling by roughly 40 per cent as a group, and are still trading 15 per cent below their peak, on an equal-weighted basis.
With the world awash in credit risk, investors have been leery of bank stocks. And for good reason. As all the major Canadian banks have reported in their earnings releases this week, profits have clearly come under pressure and substantial reserves are being built to cover loan losses.
But most of the banks managed to easily beat Bay Street earnings forecasts, in what Scotia Capital strategist Hugo Ste-Marie called a “big step forward.”
“The environment certainly remains challenging, but the sector appears well positioned to do some catch-up,” Mr. Ste-Marie wrote.
He pointed to improvements in the Canadian labour market, a modest increase in bond yields, which tend to boost bank profits, generous dividend yields, and the lowest relative valuations in 20 years – 10.5 times forward earnings for the banks, versus 18.7 times for the broader TSX.
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