The money machines

There are likely no better harbingers of the economy than the banks. These guys are huge. Stable. Well-run. Fingers in everything Regulated up the ying-yang. Safe. And never in your lifetime, or that of your great-gramps, have the banks missed paying a dividend. Not in war. Crisis. Recession. Even during Nickleback.

What are the banks telling us now? Their shares have been weak this year – so are these stocks ripe for buying, or will the banks fade further if things slow down, jobs are lost and housing is whacked?

The first two have just dropped their earnings numbers. No cigar for TD, with revenues slipping (and its stock was punished on Thursday) and more money set aside for bum loans. At RBC, the numbers were better but significant layoffs announced. Mr. Market liked that and shares jumped.

Over the past year, as you may know, bank stocks crested in February and have wafted lower since. RBC has gone from $140 to $122. The green guys were $93 during the winter and are now at $82. Overall, the bank index is off a little under 5%, while US stocks (the S&P 500) is up more than 15%. AI stuff (like Nividia) has gone ballistic. So why would you chunk portfolio cash into the Big Six or the bank-heavy TSX?

Lots of reasons. Like dividends. RBC pays 4.5% for just hanging around. TD is at 4.7%. Scotia is darn near 6.8%. These payouts also come with the dividend tax credit, which means you are receiving a greater benefit than owning a GIC at 5+%. Plus the stock is liquid (unlike most guaranteed investment certificates). And – almost without fail – the big Canuck banks sweeten their payouts to investors every single year.

Why are these behemoths under some pressure at the moment?

Simple. The same reasons you are. Interest rates have exploded higher as the Bank of Canada tightens the screws. Inevitable economic weakening means more loans will go sour (TD is setting aside $766 million this quarter for bad debts – more than analysts had predicted.). Market volatility has hit the wealth management divisions. US regional banks have been under pressure, and our guys are seeing their American exposure affected. Plus inflation. Expenses at RBC and TD are both up by almost a quarter.

So what are they doing?

As mentioned, Royal is punting people. Already almost 1,300 bodies were thrown overboard in the wealth management business (Turner Investments hired them all). Now the bank plans to release another 2,000-or-so folks from its 95,000 payroll. In short, management will do what it has to in order to cut costs, make money and provide income to investors. It’s everything capitalists desire and exactly what the NDP decries.

Watch for belts to be tightened at all of the Big Six operations over the coming year. Overhead will be reduced. Allowances for crappy borrowers and 50-year mortgage amortizations will be made. CEOs will continue to be judged on performance, not personality. This is one good reason you should own them.

By the way, TD just announced it will be buying back 90 million of its own shares – about 5% of the float. That will give a long-term uplift to the stock, and also send a signal management thinks the place is cheap.

Analysts agree. This is probably one of those bank-buying moments.

Why? Well, first, the economy may unravel a bit, but it’s not going down. Recession is unlikely, but if we get one it will be, like me, short and fuzzy. Unemployment will inevitably increase and GDP numbers fade. Financial markets will be choppy as we head into the next phase of the Ukraine war (let’s see who Putin offs next), the all-about-Trump US presidential slugfest, China uncertainty and the disruptive AI-everywhere revolution. But all that will pass. Just give it time.

Second, the CB tightening cycle is coming to an end. Maybe one more hike. Gradual cuts coming some time in 2024. Improved margins for the bankers. And a mess of mortgages renewing at market rates and with normal ams.

Third, count on the bankers to be as ruthless as necessary in reducing costs and expanding market share. Additionally, in 2024 when rates have stabilized and begin to ease (even a little) expect real estate activity to heat up again – more sales, more mortgages, bigger bank loan portfolios. And while that occurs, GIC and high-interest savings rates will tank, also aiding the bottom line.

Face it: few businesses in Canada are run better than the banks. None are more stable. No major Canadian bank will ever fail, wobble or even lean. Owning them over the decades has resulted in a fat capital gain, and meanwhile the dividend income is steady, tax-efficient, abundant and ever-plumping. And now, they’re on sale. Sweet.

About the picture: “Thank you for showing our Yorkie, Trixie on the blog a year ago when she was a 3lbs/3 months pup,” writes Alan. “One year later she’s doubled in size to a sassy and playful ‘big girl’ at 6 lbs. Unfortunately the portfolio hasn’t performed the same, but we’ve stayed with our B&D mix of etf’s and are expecting a much better 2023. Thank you for our daily dose of sanity, financial advice and common sense during these crazy times.”

To be in touch or send a picture of your beast: [email protected]

Source: https://www.greaterfool.ca/2023/08/24/the-money-machines/