U.S. Hedge Funds Betting Against Canadian Bank Stocks Again

rbc

Short interest in the big six Canadian banks has risen over the past two months, but the increase is primarily in the United States. The re-emergence of the “Great White Short” thesis has recently put downward pressure on bank valuations. “Remember that short-sellers profit from price declines by selling borrowed securities and repurchasing them at cheaper levels.

Royal Bank has seen the biggest change in short-interest positions on their shares listed in the United States. They have soared from 10 million in December 2014 to 25 million in February 2015 according to http://www.nasdaq.com/symbol/ry/short-interest

Canadian bank stocks usually outperform the overall Toronto Stock Exchange but they have had a really bad start for 2015. Investors are worried about potential loan losses from the oil patch plus a possible downturn in the Canadian housing market. Part of the downturn in bank shares in 2015 was also due to the Bank of Canada’s unexpected Jan. 21 decision to cut its overnight lending rate. Lower rates reduce profit margins on bank loans and lines of credit.

The chart below is the year to date price movement of the equal weight bank ETF from BMO (ZEB) compared to the Toronto index ETF (XIC)

 

zeb

Keep in mind that bets against Canadian banks haven’t worked in the past. U.S. investors in 2013 also shorted Canadian banks amid concerns that the country’s housing market may collapse.

The chart below represents the three-year price movements of ZEB compared to XIC

 

zeb1

Why Hedge Funds Could Be Wrong Once Again

  • Recent bank earnings beat estimates
  • Canadian banks have very little competition, there are only six of them 
  • Large loan losses in the oil patch will not occur unless the price of oil stays below $50 a barrel for the next couple of years. (Oil sands break-even is around $47 a barrel.)
  • Canadian banks only lowered their prime lending rate by half of Bank of Canada’s rate cut of .25%
  • Three out of six Canadian banks have large U.S. investments which should off-set slower Canadian loan growth.
  • The lower Canadian dollar will boost profits from their U.S. investments
  • Investing in the oil patch or commodities are not very good alternatives for Canadian investors. (We love our bank stocks)
  • Banks are also a yield play with dividends averaging 4% because the Canadian 10 year bond yield is only 1.3%
  • The dividend tax credit gives Canadians an after tax return equal to interest income of 5.5%!

I found this news article worth sharing:

“Why investors should still show Canada’s big banks some love”

Article: by David Pett in the Financial Post

  http://business.financialpost.com/2015/02/27/why-investors-should-still-show-canadas-big-banks-some-love/

My favourite is TD  Bank which I sold back in November. It is currently on my watch list. TD has more branches in the U.S. than in Canada, plus they own discount broker Ameritrade.  A rise in U.S. interest rates, later in 2015, will improve the profit margins on TD’s loan business.

I am going to monitor the short interest and wait for their next quarter earnings report before I jump back in. If I am right, hedge funds could bid up TD’s stock price even higher when they cover their short positions!

td1

td

For my Canadian readers, Monday March 2nd is the deadline for your RRSP contribution for filing your 2014 tax return.

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