The bank collapses in the U.S. and other regions have triggered a selloff in equity markets this month. In the last few days, several banks, such as Silicon Valley Bank, Silvergate, and Credit Suisse, were in urgent need of liquidity, as they are negatively impacted by a challenging macro environment.
According to a research report, interest rate hikes have now put 186 banks south of the border at risk of failure, making investors extremely nervous. As a result, the S&P 500 index has pulled back by 5.5% since the start of February 2023.
In order to avoid a major crisis, U.S. banks have borrowed close to US$165 billion from the Federal Reserve. Basically, the Fed is printing more money to infuse capital into banks. In fact, JPMorgan expects the Federal Reserve could provide around US$2 trillion to banks to avert any more big-ticket failures.
But an increase in money supply will lead to hyperinflation — a period where prices of goods and products increase, and the value of the U.S. dollar declines.
It is quite evident that investors should brace for an elongated period of rising interest rates and inflation, which will result in lower consumer demand as well as a fall in corporate sales and profit margins this year.
While U.S. bank stocks are under pressure, let’s see if Canadian banks are better positioned to get through an economic downturn.
Should you buy TD Bank and RY Bank stock right now?
Two of the largest banks in Canada are Toronto-Dominion Bank (TSX:TD) and Royal Bank of Canada (TSX:RY). Compared to the banks in the U.S., most Canadian banks are far more conservative. This allows them to maintain robust balance sheets, even when economic conditions are sluggish.
As federal banks are likely to increase interest rates in 2023, the demand for consumer, corporate, and mortgage loans will fall off a cliff. So, investors should brace for a fall in revenue and profit margins in the near term.
Alternatively, the selloff in bank stocks has already driven valuations of companies lower this March. For instance, shares of Royal Bank of Canada and TD Bank are down 14% and 28%, respectively, from all-time highs.
This drawdown in share prices has resulted in higher dividend yields for shareholders. Right now, TD Bank offers investors a yield of 4.8%, while the dividend yield for RY Bank stock is quite attractive at 4.2%.
If federal banks continue to tighten the money supply by raising interest rates, a recession is almost inevitable, which is bound to increase the number of loan defaults for both RY Bank and TD Bank.
However, higher interest rates might also act as a tailwind for RBC and TD, enabling them to improve profit margins.
The Foolish takeaway
Even if recession fears come true, a recessionary period will eventually be replaced by a period of expansion, allowing RY Bank and TD Bank to stage a comeback in the next year. Bank stocks are cyclical and allow shareholders to generate outsized gains during a bull run.
Investors should also note that while U.S. banks cut dividends during the financial crisis of 2009, most Canadian big banks maintained the payouts, showcasing the resiliency of the business model.
Right now, the valuations of TD Bank and RY Bank are very cheap. For example, TD Bank stock is priced at 8.7 times forward earnings, and RY Bank is priced at 10.8 times forward earnings. Both remain solid long-term bets in March 2023.
