The fallout from the global trade slump is spreading beyond industrial sectors and into the heart of the Canadian stock market – the big banks.
This week saw the Big Six banks conclude a rare dud of an earnings season, with three of six missing profit expectations, leading to a dip that wiped out nearly $15-billion in market capitalization from the group.
There were common pressures cited by bank chief executives, including rising consumer insolvencies and low oil prices. But the economic havoc wrought by the U.S.-China trade war is right up there among the prime culprits for the sudden weakness.
“It feels like it hit a wall this quarter,” said Bryden Teich, a portfolio manager at Avenue Investment Management. “All of that slowing that has been happening over the last year has finally hit the bank earnings.”
Up to this point, Canadian banks have been relatively insulated from global economic uncertainty, churning out profit growth as trade-centric sectors succumbed to the industrial slowdown.
Factory output was an early casualty of the trade war, as tariffs on more than US$700-billion in trade between the U.S. and China sent the global manufacturing sector into a downturn.
“Cyclical sectors that are exposed to the global trade slump saw the most pronounced dent in profits,” CIBC World Markets economist Katherine Judge wrote in a report.
Trade-exposed Canadian industries such as manufacturing, transportation and construction, collectively saw their third-quarter operating profits decline by 5 per cent year over year, the report said.
With so little clarity on global trade, companies in these sectors have been reluctant to invest in the things that drive earnings growth.
“During this period of political and economic uncertainty, we are managing our pace of exposure and remain focused on providing product support for our customers,” Scott Thomson, CEO of Finning International Inc., said during an earnings call last month.
Alain Bedard, CEO of trucking company TFI International Inc., expressed frustration with the corporate limbo brought on by the trade war. “The only problem we face, both in Canada and U.S., is the corporate world not investing,” he said in the company’s last earnings call.
The fact that Canadian banks have been resilient for so long is a testament to how much they have diversified their business lines over the years, Mr. Teich said. Extensive U.S. operations have helped the biggest Canadian banks offset domestic strains, for example.
But it was only a matter of time before the banks’ immunity wore off.
“Trade disputes and the resultant corporate decision-making paralysis that they bring about can be connected with the lacklustre capital markets activity that hurt investment banking profits this quarter,” Brian Madden, a portfolio manager at Goodreid Investment Counsel in Toronto, said in an e-mail.
Additionally, the trade war’s toll on the general economy fuelled a wave of global rate cuts by central bankers trying to engineer a recovery. And loose monetary policy tends to be bad for bank profits, which rely in part on the spread between long-term and short-term interest rates.
“The next couple of years are likely to be challenging given interest rate trends, uncertainty around global growth, trade tensions and normalized credit conditions, among other factors,” Dave McKay, Royal Bank of Canada’s chief executive officer, said in a conference call this week.
Trade protectionism was cited by Darryl White at Bank of Montreal, meanwhile, as likely leading to a modest slowing of the U.S. economy next year. And Victor Dodig, CIBC’s CEO, lowered expectations for next year’s earnings growth to low single digits.
While still a respectable pace of growth, it is a considerable step down from what Canadian investors have come to expect from the Big Six, which are responsible for driving nearly 60 per cent of the gains in the S&P/TSX Composite Index over the past five years.
“Now they’re not getting that same engine of growth from the U.S. side of the business,” Mr. Teich said. “It becomes really hard to come through with strong earnings growth in that kind of a backdrop.”
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