Why Canadian Bank Stocks Could Run Higher
Third-quarter earnings for the six major Canadian banks were on balance fairly constructive with CIBC, National Bank and Royal Bank of Canada leading the charge. Overall, the Canadian lenders delivered the first quarter of double-digit year-over-year earnings growth since the spring of 2022. The most recent inflation print showed the Bank of Canada (BoC) finally reached its goal of 2%. Overnight lending rates have come down 75 basis points (bps) in Canada and we are projected to see two more cuts before the end of the year — with the possibility of at least one oversized cut of 50 bps at one of those final meetings. Forecasters now predict the overnight lending rate will reach a “neutral” level of around 2.25% to 2.50% (potentially some time in 2025).
Under the present circumstances, it is worth asking the question: does the current rally in Canadian banks have more room to run?
Featured ETFs
- BMO Equal Weight Banks Index ETF (Ticker: ZEB)
- BMO Covered Call Canadian Banks ETF (Ticker: ZWB)
- BMO Canadian Banks Accelerator ETF (Ticker: ZEBA)
Benefits
- ZEB provides equal-weight exposure to large, diversified Canadian bank stocks
- ZWB call option writing reduces volatility while producing monthly cash distributions
- ZEBA invests in Canadian banks while earning an amplified price return of an underlying reference index up to a cap, plus dividends (before fees, expenses and taxes)
Potential Supports for Canadian Bank Stocks
Supported by BoC rate cuts, forecasters see continuing tailwinds from easing funding pressures on borrowers, resumption in loan growth, and stable credit provisions going forward. When interest rates drop this would typically encourage businesses and consumers to borrow more and in turn stimulate the Financials sector along with easing pressure on overall default rates. Canadian bank loan loss provisions should decline under such a scenario, likely benefiting bank earnings.
With the potential of more rate cuts, we are expected to see the yield curve continue to steepen. Banks tend to borrow on the short end and lend on the long end of the curve. Therefore, a steepening yield curve can be good for the banks overall.
Investors may want to consider buying BMO’s Bank ETFs. Given the wide performance dispersions between the Canadian banks as of late, one may have the opinion that not all banks are considered equal. Indeed, the dispersion is vividly illustrated in the performance spread between RBC and TD, which was as wide as 24.18% over the last 6 months. BMO’s Equal Weight strategy is designed to remove concentration risk in a particular company. With the more recent volatility among certain Canadian banks, we have seen more stable returns from ZEB and ZWB.1 Moreover, the equal weight strategy utilized for ZEB and ZWB can act as a natural buy low sell high strategy. When dispersions happen in performance with certain banks, the semi-annual rebalancing will bring the holdings back to an approximate equal weight and in turn allow you to take profits and add to other quality holdings within the ETF.
Furthermore, Canadian banks continue raise their dividends over time which bodes well for income-seeking investors. Overall, Canadian banks have a reliable dividend payment, with ZEB and ZWB boasting annualized distribution yields of 4.14% and 6.8%, respectively.2 Investors are able to benefit from regular monthly distributions from these ETFs.
Both ZEB and ZWB are low-cost solutions to gain exposure to Canadian banks. These ETFs have remained two of the largest, most liquid Canadian bank ETFs in Canada and have gathered over $6.1 billion of AUM since inception.3
Annualized Daily Returns as of September 30, 2024
Fund Name | Ticker |
Year-to-Date |
1 Month |
3-Month |
6-Month |
1-Year |
3-Year |
5-Year | 10-Year |
Since Inception |
ZWB |
14.54% |
4.36% |
13.92% |
9.20% |
25.21% |
5.31% |
7.86% | 7.37% |
8.42% |
|
ZEB |
18.58% |
6.07% |
17.78% |
12.13% |
34.11% |
8.77% |
11.33% | 9.67% |
10.93% |
Implementation
For exposure to an approximate equal weighted basket of Canadian banks, consider buying BMO Equal Weight Banks Index ETF (Ticker: ZEB) or with an enhanced yield component, the BMO Covered Call Canadian Banks ETF (Ticker: ZWB). For investors seeking the potential to accelerate growth, consider the BMO Canadian Banks Accelerator ETF (Ticker: ZEBA).
1 Performance source Bloomberg September 30, 2024.
2 As of September 20, 2024.
3 AUM Flows source BMO Global Asset Management August 31, 2024.
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Distribution yields are calculated by using the most recent regular distribution, or expected distribution, (which may be based on income, dividends, return of capital, and option premiums, as applicable) and excluding additional year end distributions, and special reinvested distributions annualized for frequency, divided by month end net asset value (NAV). The yield calculation does not include reinvested distributions. Distributions are not guaranteed, may fluctuate and are subject to change and/or elimination. Distribution rates may change without notice (up or down) depending on market conditions and NAV fluctuations.
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