McMurtry Investment Report Newsletter – April 2019

The financial sector remains the largest component of the TSX Composite Index at 31.70%. US Financials represent the third largest equity sector of the S&P 500 at 12.7%. For my North American sector weights, I continue to advise 55% in the US and 45% in Canada. This works out to be 21.25% of the total equity North American component, the single largest group on a weighted basis.

Historically the Canadian banks have been more consistent performers over time with considerably less risk than their US counterparts. During the last recession of 2008 no Canadian bank cut its dividend, but in the US it was a completely different situation. In order to avoid a total financial meltdown, the stronger US banks were forced by the US Government to acquire their weaker competitors. In that venue Bank of America bought Merrill Lynch to avoid a bankruptcy of the latter company. JP Morgan, the best capitalized US bank was also required to acquire financial institutions that were on the verge of collapse. The term “ Too Big to Fail “ was coined at that time.

Canadian banks were much better capitalized during the last recession and their coast to coast branch network system allowed them to access funds more cheaply without disrupting their overall domestic financial condition. While loan losses rose considerably for the Canadian banks, they paled in comparison to their US peers.

Canadian banks have much less competition and are considered oligopolies. There are many US banks that are not well capitalized where the competition is much more intense than in Canada.

Domestically, any type of criticism of Canadian banks from a shareholder point of view is usually brushed off. For example, a US hedge fund manager has been recommending shorting Canadian banks and the investor reaction to this has been to largely ignore this advice.

Despite the relative advantages of Canadian banks over US ones, it is still essential to determine if North American banks represent good investments at this time.

Banking has different divisions that do not all perform in the same manner. Consumer banking, the largest component, is greatly affected by the level and direction of interest rates in addition to any federal or state regulatory changes to mortgage eligibility rules. Commercial banking is not only affected by interest rates but also influenced by the state of the domestic and global economies and by the level of corporate tax rates. Both consumer and commercial banking are heavily influenced by the shape of the yield curve or the spread between short and longer maturities. Investment banking and trading is affected by many factors including interest rates, global and domestic growth and the financial health of the corporate sector. Finally, wealth management, the fastest growing division, is heavily influenced by the stock and bond market performance.

Life insurance companies are not affected nearly as much by the shape of the yield curve, but are much more influenced by the direction of interest rates – the higher the better. This is because their long-term liabilities on the balance sheet are discounted back to the present value at a lower valuation when rates rise. For property and casualty insurance companies their liabilities are much shorter term in nature and consequently are not nearly as negatively affected from falling rates as life companies are.