The encouraging release of Pfizer’s COVID-19 vaccine data has revealed a light at the end of the tunnel for the pandemic. As we said earlier this week in The Globe and Mail, should this vaccine be as effective as the early data show (an in-depth peer review process is still required) then there is no doubt it will be a game changer – a sooner-than-expected rollout will put the economy on more solid footing.
In turn, a tailwind may emerge behind the beleaguered value stocks, with banks, in particular, being among the largest beneficiaries both in the United States and Canada. From a macroeconomic perspective, a vaccine should reduce the uncertainty surrounding loan losses with more clarity on the future.
To be sure, there is the potential for more short-term pain if no new stimulus is provided out of Washington, but a clearer end to the pandemic will allow banks to reduce credit loss provisions and that flows into future profits.
Additionally, widespread adoption of a vaccine in the first half of 2021 should lead to a pickup in GDP growth. We do not feel this is unreasonable, especially considering the data from Pfizer likely mean other vaccine candidates can succeed as well.
With central banks pledging to keep yields low, this growth pickup will result in a steepening of the yield curve as the long end sees rates rise while the short end remains anchored – the larger interest rate differential ultimately providing a major boost to the banking sector (and financials writ large).
Besides the macro tailwind, another reason to consider being bullish on North American banks is that valuations have rarely been cheaper. This group is among the hardest hit from the COVID-19 pandemic – even with the bounce to begin the week, the large diversified banks in the United States are down 29 per cent for the year-to-date, the regional banks have lost 16 per cent while Canadian banks have fallen 9 per cent.
Looking at the accompanying table, such depressed prices have created an opportunity to buy the large or regional banks in the U.S. at a price-to-book multiple of 0.9 times (placing them in the lowest 2 per cent and 25 per cent, respectively, of historical readings) or the Canadian banks at 1.3 times (or lowest 3 per cent). In other words, some of the cheapest valuations on record. On a forward price-to-earnings basis, the opportunities are not as large but still rank near, or below, the bottom half of their respective histories. Additionally, on a relative basis, these stocks are trading at, or near, record discounts to the overall market (S&P 500 in the U.S., S&P/TSX in Canada). Safe to say these valuations give investors a wide margin of safety.
Despite the potential for significant price appreciation, this group is great for income investors as well – yielding 3.4 per cent for the large U.S. banks, 3.5 per cent for the regional players and 4.9 per cent in Canada. No doubt this is more attractive than the U.S. and Canadian 10-year yields at 0.98 per cent and 0.78 per cent, respectively.
Furthermore, there is a demonstrated ability to increase the dividend as well (once regulators on both sides of the border allow) with five-year annualized growth rates of 15 per cent for both the large and regional U.S. banks, and 7 per cent in Canada.
The bull case behind North American banking stocks is clear and the vaccine news from Pfizer (and likely others to come) can act as the catalyst. It is important to remember that a return to “normal” means the same structural issues facing the economy will persist as they did prepandemic – meaning that the rotation into value stocks is likely to be a trade and not a trend. For those traders and investors who are looking to benefit, U.S. and Canadian banks offer a way to do so with an attractive risk/reward profile.
David Rosenberg is founder of Rosenberg Research, and author of the daily economic report, Breakfast with Dave. Marius Jongstra is an economist with the firm.
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