Canadian banks can say one thing about 2010 - at least it wasn't 2009, or 2008.
While the shares of the country's Big Six banks - which make up almost 20 per cent of the S&P/TSX composite all by themselves - collectively eked out only a small gain this year, considerably lagging the overall market, it was an improvement over the losses the sector suffered in the previous two years. It's little coincidence that the bank stocks have been in a rut ever since the financial crisis convinced all of them to put their previously regular-as-clockwork dividend increases on hold.
But now, we see a glimmer of a brighter future. National Bank of Canada raised its dividend recently, fuelling expectations that the other banks will follow suit in 2011. Quarterly earnings released in the past few weeks were, for the most part, stronger than expected.
Might this mean that Canadian bank stocks are a good buy for investors heading into 2011? Well, perhaps, says Murray Leith - but only if you let shorter-term greed overrule longer-term fears.
Greed is good
Mr. Leith, director of research at Odlum Brown Ltd., said the prospect of dividend increases, coupled with already-attractive dividend yields (they average almost 4 per cent across the Big Six), "will drive Canadian bank shares higher" over the near term. That should be underpinned by solid operating results, "as long as the global economic recovery remains on track."
The dividend yield, he noted, looks particularly attractive relative to the prime alternatives for income-seeking investors - bonds. The average bank dividend yield continues to exceed that of Canadian government 10-year bonds, and aren't far from typical high-quality corporate bond yields. Historically, bonds have yielded well above bank dividends, as a result of the prospect for capital gains and the expectation of dividend hikes.
And as Mr. Leith's accompanying table shows, at least some of the banks look to be in a position to bump up their dividends in 2011, based on forecast earnings and their own target ranges for their dividend payout ratios.
(, Bank of Nova Scotia , Canadian Imperial Bank , Royal Bank of Canada , Toronto-Dominion Bank )
Fear the economy
Over the longer term, though, Mr. Leith fears that the Canadian economy could underperform, because of high levels of consumer debt and an expensive housing market, both of which could hit home for the banks, as well as the high Canadian dollar and the risk that elevated commodity prices could reverse.
He added that Canadian bank stocks are trading at a premium relative to their global peers, which could leave them susceptible to a selloff should Europe's debt problems deepen.
"Investors who are overweight Canadian bank shares [greater than 20 per cent of overall equity holdings]should consider diversifying into other sectors with better risk and return attributes," Mr. Leith said.