Podcast: Q2 Bank Earnings a Mixed Bag - May 24, 2023

As second quarter earnings results trickle in, two Canadian banks fell short of analysts’ expectations. On today’s episode, portfolio managers Alfred Lee, Chris McHaney and your host, Mckenzie Box, examine the markets’ initial reaction. They also discuss higher loan-loss provisions, gold prices, factor-based ETFs, the U.S. debt ceiling deadline, and investing in China. 

Mckenzie Box is Director of Product and Strategy at BMO Global Asset Management. She is joined on the podcast by Alfred Lee and Chris McHaney, Portfolio Managers and ETF Specialists at BMO Global Asset Management. 

The episode was recorded live on Wednesday, May 24, 2023.

Episode Summary

Gold and Gold Equities

The price of gold is up ~ 8.5 year to date in US dollar terms. Our Equal weight Global gold ETF - ZGD is up about 16% and our Equal Weight Junior gold ETF - ZJG is up 14 % year to date in Canadian dollar terms. Gold and gold stocks have gotten support from a weakening US $, the US Dollar Index, which is a trade weighted basket versus six other currencies, it is down 9.5% Since September 2022, which was the peak. Gold has recently hit levels of technical resistance at $2050 per ounce and has started to retreat. Over the long term however, there are a lot of long term reasons in which investors may want to be a little bit more bullish of gold, or at least have a small position in their portfolios. The US debt ceiling, the on going the US banking crisis, potential for rate cuts from the US federal reserve which will cause the dollar to come down in value and central bank buying across the globe are all supportive of gold. Equities look attractive as they mine at spot prices and have the ability to sell them at higher prices in the future as prices rise.

Canadian banks

So far we’ve seen Bank of Montreal and Bank of Nova Scotia released their earnings both results were mixed, weakness in capital markets business and increased expenses pulled down earnings throughout the recent quarter. We also saw some higher loan loss provisions, specifically over 700 million from Bank of Nova Scotia and over $1 billion from Bank of Montreal, both banks are setting aside capital to cover loans that they expect could potentially go bad in the future. We expect banks to do the prudent thing and set aside some more money for loan loss provisions going forward. This will potentially hurt earnings a little bit however it is worth mentioning that both banks, despite this challenged earnings environment raised their dividends. Investors can gain access to the space with BMO Equal Weight Banks Index ETF - ZEB, valuations are beginning to look attractive at these levels and our ETF is yielding 5 %. Historically Canadian banks don’t generally have a 5% dividend yield for too long and we expect the share prices to recover in the long run. Higher interest rates environments are generally a tailwind for banks and with recent selloffs these are attractive entry points.

Broad markets : Potential catalysts & risks on the horizon

Both equities and bonds have made a pretty decent comeback despite the Fed not having given up any legitimate cues for softening its monetary tightening. The NASDAQ is up roughly 21% S&P 500, up around 9% and the S&P TSX composite roughly around 4.8. The BMO Aggregate Bond index ETF - ZAG , which is the broad Canadian bond market is up around 2.6% year to date. In terms of catalysts in the US especially last earnings cycle, a lot of the S&P 500 companies reported very strong earnings with quarter over quarter, quarter, quarter over quarter earnings per shares, coming in ahead of expectations. When you look at valuations of the market specifically at PE ratios as a gauge, currently in line with their long term average. Prices of the S&P 500 companies haven’t really moved in lockstep with the increase in earnings as a result there is a potential for further multiple expansion, if prices were to move up with earnings.

The US debt ceiling is another important catalysts. If we do get a resolution this should be supportive of not only the equity market, but also the bond market as well. Finally inflation, even though we’ve been talking about inflation for pretty much over the last two years, still very much, you know, a concern for a lot of investors. Both CPI and PCE as gauges for inflation continue to trend in the right direction. If we continue to see inflation continue to come down, that should be a catalyst for risk assets to move higher, as that would basically imply that the Fed would have less tightening to do, which should also be supportive of equities and bonds going forward.

One of the major risks and ongoing concerns is the health of the recent market rally. A lot of the performance has come from a small number large cap US tech companies only, we would like to see the breadth of the rally get better and more companies participating in share price growth this would increase the health of the rally and create more stability.

The other large concern out there is the the inversion of the Treasury curve, typically when you see the yield curve invert, this is one of the most reliable indicators for a pending recession as a result this is a reason to be concerned. he good news on the recession front is that when you do look at the labor market, the labor market continues to be very strong so if we do end up with a recession it will likely be more shallow then previous ones.

With the recent run up in broad indices a good strategy may be to take some gains and move into to some factor based ETFs. A good combination to look at is low volatility and quality as they compliment each other and create more diversification. Investors can look at combining US Low volatility Equity ETF - ZLU and combine it with our USA High Quality Index ETF - ZUQ. Over the last 10 years annualized returns have been a little bit higher and returns are better from a risk adjusted perspective. The other thing to consider is that with this approach you get a lot more downside protection with the Low Volatility ETF then you would if you had your whole portfolio in the S&P 500.

Combining factors like low volatility, and quality is a great way for investors to remain invested, but at the same time position themselves more defensively as there are a few risks that we highlighted in our podcast.

Source: Bloomberg, All returns and data points April 2023.