The Canadian financial sector’s share of the country’s benchmark stock index, the TSX, is at its highest level in eight years, underscoring investor enthusiasm for bank shares and nervousness about energy and materials.
The financial sector now accounts for 37 per cent of the TSX, reducing the diversification benefits of owning a broad index and leaving investors exposed to an eventual drop in financial shares.
The TSX has outperformed the S&P 500 in 2025 and so far this year in part because it offered an alternative to highly tech-concentrated U.S. indexes.
Canada’s Big Six lenders – Royal Bank of Canada (RY-T), Toronto-Dominion Bank (TD-T), Bank of Montreal (BMO-T), Bank of Nova Scotia (BNS-T), Canadian Imperial Bank of Commerce (CM-T) and National Bank of Canada (NA-T) – are among Canada’s biggest financial companies and control a large chunk of the market.
After several banks posted consecutive quarters of double-digit earnings growth, they are trading at near multidecade high valuation levels, prompting some investors to question whether future earnings growth can keep pace with lofty expectations.
“That is an area of concern for me and it’s been for quite some time,” said Michael Dehal, a senior portfolio manager at Dehal Investment Partners at Raymond James. “If the earnings cannot live up to the multiple, you are going to see the price decline and that’s going to weigh on the TSX.”
Financial stocks have outperformed energy and materials, which includes mining shares, since the U.S. attacked Iran in February, as gold prices fell and hopes of a peace deal arrested a spike in the price of oil.
Since February, financials have climbed 22 per cent, compared with a 7-per-cent gain for energy and a 25-per-cent drop in materials, although miners have clawed back some losses in recent days. As recently as March, financials accounted for 31 per cent of the TSX, according to LSEG data.
Investors remain largely positive about the country’s financial sector. The five largest Canadian bank stocks are trading at an average of 15 times forward earnings, an estimate of future profits for the next 12 months. The top five U.S. banks, in comparison, trade at 12 times their forward earnings.
Canadian bank stocks are the most expensive they’ve been since 2010, when compared with the top five U.S. bank stocks. Even so, Veritas Investment Research analyst Shalabh Garg in July upgraded his view on Canadian banks, recommending that investors at least maintain a market-weight exposure to the Big Six banks, from an underweight position.
“Although the macro backdrop remains uncertain, we believe the Big Six banks can sustain current premium valuations, as they are largely immune to potential disruption from AI tools, will continue to benefit from constructive financial markets, and are unlikely to face a systemic credit event in the near future,” he noted.
The big banks, five of which are among the 10 largest Canadian companies, have bet on diversifying their revenue streams, with a large portion coming from capital markets and wealth management. Market uncertainty has boosted income from their trading business, while an uptick in investment banking activity has brought in more fee income.
Retail clients have shown more resilience as savings rise and mortgages are paid on time, while the Canadian economy has shown signs of improvement despite uncertainty owing to U.S. tariffs. Strong underwriting practices have helped banks maintain strong loan books. At the same time, investments in AI are expected to boost savings for the banks.
Over the past few years, banks have built strong vaults to protect themselves against potential loan defaults, which could add to earnings growth if those loan losses do not materialize and the banks can release those provisions.
“They’re proving their competitive advantages at every segment, and now you’re seeing the payback,” said Anthony Visano, managing director at Toronto-based investment management firm Kingwest & Co.
Mr. Visano said that historically, when the sector has held a similar weighting, financial stocks have outperformed the broader index over the following 12 months, returning an average 20.5 per cent versus 14.5 per cent for the TSX.
Canadian banks start reporting earnings the last week of August.