Canadian bank stocks are as hot as can be after gaining major ground in the past two years, with the average Big Six titan more than doubling over the time span. Obviously, this kind of momentum can’t last forever, but at the same time, if things all align for the big banks, there’s really no telling how this smooth ride higher will end.
Indeed, it feels like the big banks are long overdue for some kind of vicious valuation reset or, at the very least, a mild, run-of-the-mill correction. The bank stocks are starting to look just a tad on the overvalued side. After all, it has been quite a while since the big banks were trading with price-to-earnings (P/E) ratios in the high teens.
And if this red-hot run continues onward into the fourth and final quarter of the year, the 20 times P/E could become the new normal, as could the 2% yield. For income investors who’ve gotten used to the banks trading in the low-teens P/E with a 4-5% dividend yield, it feels like the banks are too frothy to even think about touching at this juncture, even after yet another strong season of quarterly earnings results.
Another big season of earnings is just weeks away
For the most part, the latest bank earnings season was impressive. Though not every Big Six bank rallied out of the gate, especially given what were some pretty elevated expectations going into the summer season. BMO Equal Weight Banks Index ETF (TSX:ZEB), my favourite way to bet on Canada’s Big Six is up 33% year to date but 0% in the past month.
Indeed, a lot rides on the coming wave of earnings, and I think the stakes are just a bit too high to warrant “playing” the names ahead of the big quarterly reveal.
As investors digest the strong numbers while looking out to the late-August earnings season, questions linger as to whether the big banks can keep up the big beats. The expectations bar is just a bit higher, but, for the most part, I think that it’s a bad idea to bet against the Canadian banks as they face their toughest test yet.
In my view, I think there’s no rush to pick up shares of the big bank stocks going into earnings. The trajectory has really flattened in the past several weeks. That’s only healthy, at least in my humble opinion, after the explosive rally that preceded the sideways action.
While I’m not against buying some of the banks before the bell if you’re looking to initiate a long-term position and average into a larger position into any weakness, I think that waiting things out could be the move, especially since stretched P/E multiples and strong results being a given could pave the way for a flat-to-negative reaction.
The bottom line
Even a good number could be met with selling if a “sell the news” kind of reaction unfolds, given how heated the big banks are right now as they flirt with all-time highs with a bit less momentum behind them.
Indeed, a quarterly blowout would be just what the banks need to enjoy another leg higher, but unless you’re willing to put up with stiff downside risks, I’d much rather be a buyer after the earnings season ahead. The banks are unstoppable, but with a low yield and hefty price of admission, I’d say that fortune favours the holders.