It’s become common practice in recent quarters for analysts and investors to debate whether Canada’s biggest banks would get tripped up by the latest headwinds – be they the collapse in crude oil prices, credit quality concerns, low interest rates, or any number of other risks.  For the most part, the lenders have routinely demonstrated their resilience – often sprinkling in some sweeter dividends to reward their shareholders. 

Despite the banks’ propensity to defy their skeptics, one analyst is warning on the eve of another earnings season that the Canadian bank stocks’ recent price gains don’t jibe with a murky outlook for the economy.

“Year-to-date, the Canadian banks are up 10 per cent, outperforming the S&P/TSX Financials by roughly 500 bps,” Barclays Analyst John Aiken wrote in a report to clients on Thursday. “We believe the banks’ strong valuation run has not been necessarily driven by fundamentals.”

Instead, Aiken argues, the stock price gains are due to recovering oil prices, diminished short interests, the appeal of Canada as a ‘relative safe haven’, and investors’ appetite for yield in a low interest rate environment. 

Bank stocks have defied recent Canadian GDP numbers, as the economy contracted 0.6 per cent in May in the wake of the Fort McMurray wildfires. The country’s economic outlook is further compounded by low oil prices and a “paradoxically stronger Canadian dollar.”

“For the latter part of 2015 and early 2016, the bank valuation multiples tracked the downward (and one upward) revision to 2016 GDP growth expectations by the Bank of Canada,” Aiken wrote. “However, with the most recent downward revision, valuations broke rank and improved, even as the outlooks for 2016 and 2017 were reduced once again.”
 

While dividend yields may be behind the banks’ surge, mitigating economic factors cannot be overlooked.

“[T]his fixation on yield ignores the fact that the banks’ valuations are moving away from previously highly correlated factors (energy prices and the steepness of the yield curve),” according to Aiken, “and, more importantly, deteriorating expectations for the Canadian economy as a whole.”

Aiken also cautioned yield-hungry investors they will need to wait a while to see any of the banks sweeten their payouts; he predicts there won’t be any dividend hikes from the banks until next year. 

Against this backdrop, the Canadian banks prepare to release third-quarter earnings. Bank of Montreal gets the ball rolling on Tuesday, followed by Royal Bank on Wednesday, and then CIBC and TD on Thursday. Scotiabank rounds out the Big Five on Aug. 30.

The importance of earnings, however, highlights a flaw in the big banks’ priorities, according to CIBC Capital Markets Analyst Robert Sedran.

In a report titled “No More Gold Stars For Operating Leverage, But ...,” Sedran stated that banks need to budget for the long-term and worry less about meeting quarterly expectations.

“Much as management would like to take a long-term view on organizational design, heaven help the bank that misses consensus by a few pennies owing to higher than forecast investment spending,” wrote Sedran. 

“Management will have to take a long-term view and worry less about quarterly reporting.”

The banks’ respective ability to walk that tightrope, CIBC wrote, would mark the divide between the Big Five in terms of growth and valuation.