RBC Market Update - Week of February 22-26, 2021

February 26, 2021 | Eric Janitis


"Having a proper plan, staying level-headed, employing a disciplined process of rebalancing and due diligence at all times is a strategy for long-term investing success."

Investors continue to be on edge about rising bond yields, which moved higher yet again over the past week. Anxiety persists despite commentary from U.S. Federal Reserve Chairman Jerome Powell who reiterated that any inflationary pressure this year is unlikely to force the central bank to change its approach around interest rates. Below, we discuss the Canadian banks which reported strong earnings results this past week, a potential reversal of trends on the virus front in North America, and reflect on the year ago period which marked the beginning of a tumultuous year for global equity markets.

Coronavirus Update

This week can be characterized as a minor setback in North America as the improving trend that had been witnessed over the past month appears to have stalled. Canada’s 7-day average rate of new daily infections rose modestly to nearly 3000 from 2900 previously, the first increase in some time. It was led by increases across British Columbia, Alberta, and Ontario, while case infection rates across Quebec, Saskatchewan, the Maritimes, and the northern territories all declined. Meanwhile, in the U.S., the 7-day moving average of new daily infections is near 63,000, below the 69,000 from the week ago period, but here too there are signs of slowing progress. The next few weeks will help clarify whether this is a temporary reversal of trend, or the start of something more concerning, and frustrating, like a third (or fourth) wave, which is anticipated to occur over the next few months.

Strong results from Canadian banks

The Canadian banks have performed well to start the year. That trend continued over the past week as they reported their first quarter earnings results for the period November through January.

The results unveiled two predominant themes. First, the credit issues that arose at the onset of the pandemic last year are now subsiding. Each bank reported significantly lower than expected provisions for credit losses. These are capital cushions of sorts that the banks set aside to absorb future losses from loans that consumers and businesses may struggle to repay. As banks believe they are adequately prepared and begin to anticipate lower future losses, they tend to provision less, and may even release and redeploy this capital. The second theme that was apparent from the results was the stronger than expected revenue growth across many business lines of the Canadian banks: commercial and retail banking, capital markets, and wealth management for example.

Investors are now left to wonder what to expect from the banks going forward? We foresee more of what transpired this past quarter. More specifically, we expect credit will continue to fade as a headwind, while the reopening of the global economy should act as a meaningful tailwind for revenue growth. This latter point will prove more significant as the year goes on with more businesses and consumers gaining confidence in their ability to invest and spend, thereby requiring the many products and services offered by financial institutions. Moreover, the rise in bond yields we have witnessed to date is a powerful tailwind to the banks’ net interest margins, a critical source of profits for the banks that measures the difference between the interest income they earn and interest expenses they pay. Overall, the operating environment has shifted meaningfully over the past year, and we expect revenue growth to be a driver of potential upside to earnings expectations for the sector.

On the dividend front, we expect key regulators to consider lifting the restrictions on bank dividend increases, potentially by the end of the year, paving the way for mid-single digit dividend growth to resume over the next few years. Investors should be left feeling more confident in this sector, particularly with valuations that remain inexpensive.

Reflecting on February 2020

The Covid-19 virus is widely acknowledged to have first surfaced in late 2019. But global equity markets began to take it very seriously in late February 2020 after the first fatality from the virus in Italy was reported, which then led to a broad outbreak across Europe and ultimately throughout the rest of the world.

Global equity markets initially fell by over 30% between late February and March 2020. But, one year later, most equity markets have made up the lost ground, with many now trading at new highs. There are a host of reasons why, from governments and stimulus, to central banks and low rates, and promising vaccines.

The investing experience over the past year serves as a useful reminder that while it is easy to fall victim to human emotions and panic at the onset of a crisis, it is not helpful and can be detrimental to outcomes. Instead, having a proper plan, staying level-headed, employing a disciplined process of rebalancing and due diligence at all times is a strategy for long-term investing success.

Should you have any questions or concerns, please feel free to reach out.