CIBC: Canadian Bank Stocks Fell 24% in Past Rate Hikes

Canadian bank stocks have historically underperformed during periods of rising interest rates, but current market dynamics may alter that trajectory. According to data from CIBC, the sector suffered an average peak-to-trough decline of 24 percent across seven rate-hiking cycles since the early 1980s. This drawdown typically lasts eight to nine months, outpacing the 18 percent average decline for the TSX Composite and the 16 percent drop for the S&P 500 over the same historical periods.

The Bank of Canada held its key interest rate steady for the seventh consecutive meeting in early September, noting increased inflation risks driven by geopolitical instability in the Middle East. While the United States Federal Reserve recently raised its benchmark rate by 25 basis points to a range of 3.75 to 4.0 percent to combat inflation, the BoC remains cautious. However, the probability of a rate hike before year-end has risen, prompting analysts to reassess the impact on the banking sector's earnings and stock valuations.

Historical Drawdowns Shape Sector Expectations

Paul Holden, an analyst at CIBC, highlighted that the historical range for bank stock declines during hiking cycles varies significantly, from a 14 percent drop in 2004-2006 to a 35 percent decline in 1986-1989. He noted that while higher rates can boost short-term profit margins, they often slow loan growth and increase credit losses as consumers struggle with higher debt servicing costs. This dual effect has traditionally created a net negative for bank equities in the immediate term following rate hikes.

Government Investment Mitigates Credit Risks

Gabriel Dechaine of National Bank of Canada argues that the current environment differs due to federal strategies targeting the natural resources and defense sectors. He suggests that a potential capital expenditure super-cycle could stimulate credit growth that defies conventional expectations. While consumer loan growth slowed from 14 percent in 2022 to 4 percent in 2024, Dechaine believes commercial and wholesale loan growth could accelerate, offsetting pressures on retail credit.

Dechaine posits that multi-year 'nation-building' projects may keep credit losses at a higher-than-average plateau rather than causing a spike. This structural support allows banks to maintain profitability despite higher rates, as the demand for commercial financing remains robust. The analyst emphasizes that this shift in loan composition changes the risk profile for lenders compared to previous cycles driven primarily by consumer spending.

Analysts Favor Specific Lenders Over Sector

Given these diverging factors, both analysts recommend selecting specific institutions rather than betting on the sector as a whole. Dechaine favors Toronto-Dominion Bank, citing its superior net-interest margins and balance sheet capacity to support increased domestic credit demand. Holden suggests investors add weight to defensive names, specifically Royal Bank of Canada and TD, to navigate the uncertainty. As reported by Financial Post, this selective approach reflects a belief that individual bank fundamentals will drive performance more than broad macroeconomic trends.