Canadian Banks vs. US Banks & Crude Oil Continuous Contract (CL.F)
What a difference a week can make in the markets, sometimes it can feel like a day, sometimes a year. In last week’s edition of the Equity Leaders’ Weekly the main concern was high inflation, a hawkish Fed and rising interest rates…good times. While we highlighted the interest sensitive Utilities sector as particularly struggling, we did mention weakness in Regional Banks in passing.
Almost immediately after completing last week’s issue, financial problems in the banking sector exploded into the headlines. Problems in the financial sector which had started in the cryptocurrency area last fall, expanded to last week to include regional banks where US government had to step in and backstop deposits in order to diffuse a growing run on the banks. This week, major US and global banks have come under fire with Moody’s downgrading its outlook for the US banking sector and Credit Suisse running into financial troubles overseas, dragging down European equities and currencies with it. The selloff has also widened out into the broader Financials sectors with insurance companies, who also hold large bond portfolios, brokerages, and real estate companies coming under pressure.
Stresses in the financial system have sparked a stampede out of risk markets. In addition to the equity market selloff, Crude Oil, Copper, and grains have come under heavy pressure indicating a growing concern about the health of the global economy and a weakening outlook for resource demand.
On the flip side, capital has been rotating back into traditional defensive havens, Gold and Silver have soared and even the Japanese Yen has reasserted its role as a safe haven play. Bonds have also started to attract some support with treasury yields falling.
On that note, the US 10-year treasury note yield has dropped off quickly from the 3.90s% a week ago down into the 3.40s%, indicating that investors are expecting that central banks may need to pause or potentially even reverse their recent hawkishness if financial market stresses and/or global economic conditions worsen.
The European Central Bank meets today, but the main upcoming event is the US Fed decision and forecasts due at 2:00 pm EDT on Wednesday. Just a week ago, US Fed Chair Powell was quite hawkish, warning that the US central bank may need to re-accelerate the pace of interest rate increases. Now, Powell and the rest of the FOMC find themselves stuck between a rock and a hard place. If the Fed is too hawkish, investors could fret over tightening monetary policy potentially tipping the economy into a recession. If the FOMC is too dovish or hits the panic button, however, investors may worry that conditions are even worse than feared. In addition to the actual decision, any changes to future interest rate projections by FOMC members may also attract attention.
Even in an equity market retreat, there have been significant difference in relative performance between sectors. Out of the 31 groups that SIA Charts tracks, the worst 5 performing groups have been Banking, Insurance, Energy, Automotive, and Consumer Durables, so mainly financials and cyclicals. The five relatively strongest groups (smallest declines) have been Utilities, Health Services, Food & Beverages, Drugs and Telecommunications services, all historically seen as defensive groups.
In this week’s issue of Equity Leaders Weekly, we compare the relative performance of Canadian and US banks in previous episodes of financial stress, and take a look at the implications of continued declines in the price of crude oil.
Canadian Banks vs. US Banks
With the US financial sector running into problems once again, it appears an opportune time to take a look at the relative performance of Canadian banks compared with their US counterparts in times of stress. For this comparison, we have looked at the relative performance of the iShares S&P/TSX Capped Financials Index ETF (XFN.TO) versus the SPDR S&P Bank ETF (KBE).
The Canadian banking sector, dominated by a small number of integrated financial giants still called banks but whose operations encompass a wide range of financial services. The highly regulated Canadian financial sector has tended over time to be more conservative and less volatile that its US counterpart, which has helped the sector to weather previous storms.
A comparison chart of XFN.TO versus KBE using CAD as a common currency shows that even after factoring out currency differentials, the Canadian banking sector outperformed its US counterpart between 2007 and 2012, then underperformed through to 2018, and has been increasingly outperforming since then (arrows).Over the last fifteen years, there have been six periods when Canadian bank outperformance accelerated, most of which coincide with times of financial stress. These include: the collapse of the US housing bubble in 2007, the Great Financial Crisis of 2008, partial nationalization and the auto sector collapse in early 2009, S&P downgrading US bonds in 2011, early 2019, and now the early months of 2023. Any further outperformance would confirm the start of a new upswing, and the ratio still has room to run before approaching its 2011 peak.
Crude Oil Continuous Contract (CL.F)
Crude Oil (CL.F) has been a significant driving factor in the inflation story over several decades including the last two years. Coming out of tumultuous 2020, Crude Oil started to climb in earnest in 2021 and then spiked in early 2022 when the War In Ukraine started, at which point it helped to push inflation up to the point that central banks around the world were forced to embark on aggressive interest rate hiking campaigns.
Last June, CL.F failed to break through $122.60 resistance for a second time and has been steadily backsliding since then. A new downtrend of lower highs and bearish pattern completions has emerged over the last nine months. This change in direction coincided with the last round of COVID lockdowns in China and a weakening outlook for energy demand as concerns about a potential global recession grow.
This month, after faltering at another lower high, CL.F has broken down again, completing a bearish Double Bottom and a Bearish Catapult. Based on vertical and horizontal counts, next potential downside support for Crude Oil may appear near $55.20 or $49.05, or perhaps the $60.00 or $50.00 round numbers. Initial resistance on a rebound may appear between the $75.00 round number and $76.40 which is based on a 3-box reversal.
As one of the more volatile and significant components of inflation, falling oil prices may continue to drag inflation back downward, easing pressure on central banks to remain hawkish and perhaps enabling them to pause their tightening programs and battle the growing stresses in the financial system.
A gap in performance between CL.F, and some of the major energy ETFs had opened up then the oil price turned downward last summer. Should crude oil continue to retreat, energy related stocks may be vulnerable as well.
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