RBC and National will outperform in bleak economy: analyst

An analyst who covers Canadian banks warns of choppy waters ahead and urges clients to take a more defensive approach as economic uncertainty threatens to send stocks tumbling.

CIBC Capital Markets’ Paul Holden raised his recommendation for Royal Bank of Canada and National Bank of Canada to outperform (equivalent to a buy) versus sector performance (equivalent to a hold) . He cited their capital levels, earnings diversification and lower relative credit risk as the basis for his favorable recommendations.

In contrast, Holden downgraded Bank of Nova Scotia, Toronto-Dominion Bank and Canadian Western Bank from neutral to outperforming.

Holden cut its price targets on the seven banks it covers by an average of eight percent. Canadian Western Bank was singled out with the most severe reduction in price target (16%, to $38.00 from $45.00). The most modest reduction in price target was in Royal Bank of Canada shares (1%, to $149.00 from $151.00).

“Our prior investment thesis was premised primarily on strong loan growth and higher interest rates. In other words, we had taken a pro-cyclical stance. That view is now changing as we look to to comments from the Federal Reserve, warning signs in rates markets and U.S. bank actions,” Holden wrote in his report to clients.

He noted that Canadian bank stocks have fallen around 4% on average, outperforming over the past three months compared to US stocks which have lost around 18% of their value amid growing concern over the outlook. economies as central banks seek to raise interest rates.

Holden said his estimates are based on the assumption that central banks will succeed in threading the needle by tightening monetary policy.

However, he acknowledged that this assumption carries risks and that central banks could overshoot by tightening too aggressively and thus tip economies into recession; or they could act too cautiously and allow stagflation to set in.

Holden’s models show that the big six banks, excluding CIBC (which it doesn’t cover), could see their earnings per share for fiscal year 2023 fall by 33 and 31 percent, respectively, in the scenarios. recession and stagflation.

“Canadian bank stocks are not priced on the same economic risks that have already been priced into the bond market and US bank stocks. We’re not calling for a 2023 recession as a base case scenario, but we can’t just dismiss that possibility as inconsequential. Our analysis shows that there could be (approximately) 30% downside if a recessionary scenario were to occur,” he wrote.

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