Investors betting against Canada isn’t new and it certainly didn’t work the final time investors felt so pessimistic concerning the country’s future. But a lot of short money is sitting on the sidelines and watching the Canadian banks following the crash in oil prices and also the resulting damage to the country’s economy.
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Interest in shorting – borrowing shares and then selling them with the expectation that they will decline in value and could be bought back more cheaply to make a profit – has returned as new fears arise about the health of the Canadian economy.
The before around, shorts bet the housing industry was on the verge of crashing. This time around they expect a lot of the same, but now have an economic bogeyman they are able to pin their hopes on: oil’s price collapse and the resulting economic fallout.
Dismal economic data has invigorated short sellers this season. Canada’s gdp shrunk 0.2% in January and registered no growth in February. Bank of Canada Governor Stephen Poloz said he expects the first-quarter data will look \”atrocious.\”
The longer that atrocious data continues, the higher the short positions are required to grow.
There continues to be a lot of money waiting on the sidelines to short Canadian banks
\”There is still a lot of money waiting around the sidelines to short Canadian banks,\” said John Aiken, financial services analyst at Barclays Capital.
But do the shorts have the courage to go all in from the Canadian banks once more? After all, betting against them has not been a winning trade and also the last time the shorts made such a play, they lost – big.
Known as the Great White Short, hedge funds 2 yrs piled into a trade that bet bank stocks would plunge because the overheated housing industry crashed. By early 2013, short positions against the country\’s biggest banks such as Royal Bank of Canada were at record levels.
Unfortunately for the short sellers, a collapse home based prices never materialized, forcing these to eat huge losses. Bank stocks rallied nearly 20% in the first 1 / 2 of 2013, and short positions had evaporated by the second half of the year.
David Baskin, president and founding father of Baskin Wealth Management in Toronto, points out that since 1948, Canadian bank stocks have averaged an annual return of 10 %. And none of the big six banks have cut their dividends since National Bank of Canada halved its shareholder payout in 1992.
\”One from the great losing bets has been against Canadian banks,\” Baskin said. \”They just keep making money and giving it back to shareholders.\”
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Nevertheless, if the first quarter of this year can be considered round two within the short seller battle, it had been a good one for the shorts. The S&P/TSX Capped Financials Index fell three per cent during the three months ending March 31. But the index has bounced back since then, and is now flat for the year.
More importantly, many banks beat expectations in the first quarter, despite the fact that analysts had feared a decline in profits concerning was a lot weighing against Canadian bank earnings.
The Bank of Canada cut its benchmark interest rate by 25 basis points to 0.75%, eating into lending margins, and also the crash in oil prices and slowdown in Canada\’s economy raised fears concerning the deterioration in credit quality.
That is exactly what the shorts are eyeing most closely – any deterioration in credit quality
\”That is exactly what the shorts are eyeing most closely – any deterioration in credit quality,\” Aiken said.
But credit quality remained surprisingly strong within the first quarter as a slowdown in borrowing failed to materialize. For instance, Toronto-Dominion Bank’s retail arm grew year-over-year earnings by eight percent.
Canada\’s banks are not out of the woods at this time. The Bank of Canada in January cut rates to provide \”insurance\” against oil’s price crash, but signs continue to point to the continuing damage to the Canadian economy, specially the labour market.
The number of people getting employment insurance benefits in March rose 2,600 to 517,900, led by a huge jump in Alberta. EI claims in the province rose 8.9 percent for the month, the 5th consecutive monthly increase and also the biggest single jump since June 2009.
Such bleak economic data are required to weigh on the banks because they start reporting earnings next week, with Bank of Montreal and National Bank of Canada first of all on May 27. But Aiken asserted he does not expect the shorts to get enough grim data to aid their cause.
\”We expect Q2 to be really much like what we\’ve seen in the last handful of quarters, that\’s, relatively static earnings,\” he explained. \”We expect credit to weaken a bit this quarter, with a continued slowdown in domestic loan growth as Canadian households delever, possibly some harm to loan volumes due to Alberta, but nothing severe by yet.\”
What shorts will be looking for should come later this year, he said, if credit quality continues to be hurt by the fallout from oil\’s collapse and loan growth keeps falling.
Baskin, however, expects the shorts to get burned again. He explained Alberta does not comprise a substantial enough part of bank earnings to reverse profits which the diversity of many Canadian banks – using their growing foreign presence and enormous capital market divisions – ensures profits won’t go how a shorts are hoping they will.
“Maybe you will see some auto loan defaults, but I just don’t begin to see the kind of capitulation needed for shorting Canadian banks to be a good idea,” he explained.
Aiken agrees Canada’s banks could once again disappoint short sellers, but only if oil prices continue their recent rally and also the BoC is right about a stronger other half. Either way, he predicts pressure from short positions will put a cap on Canadian bank stocks this year.
“The?problem with short sellers is they’re very persistent,” he explained. “Players shorting now are not same players as the ones that were shorting 2 yrs ago. We have seen this like a longer trade.”