Banking on Value (Lee)

Banking on Value
Canadian Banks Looking Fundamentally Attractive

Alfred Lee, CFA, CMT, DMS, Vice President & Investment Strategist
BMO ETFs & Global Structured Investments, BMO Asset Management Inc.
alfred.lee@bmo.com

June 26, 2012

Recent Developments:

• The Canadian equity market has faced some significant selling pressure since February 29, 2012 with the S&P/TSX Composite Index (S&P/TSX) falling 8.7% on a total return basis since that time. Although there are a number of wildcards in the global macro-economic landscape that can lead markets lower, from a fundamental perspective, valuations in certain areas have become extremely attractive.
• The Canadian banks as a group trade at a current price-to-earnings (P/E) ratio of10.6x, which is just slightly higher than its 9.3x P/E low during the 2008 financial crisis. Though valuations on the banks as a group can become more inexpensive, this could prove to be a good opportunity for longer-term investors to pick-up some quality companies at relatively low prices. While the global financial system has faced some headwinds, the Canadian banking system was again announced the most sound in the world by the World Economic Forum for the fourth year in a row. (Chart A)
• As widely anticipated, the U.S. Federal Reserve Board (Fed) announced the extension of its "Operation Twist¹" program last week. This will allow the central bank to flatten its yield curve, keeping interest rates lower for a longer period. However, its actions indirectly affect the monetary policies of other central banks, especially that of Canada's. Although a flatter yield curve tends to be a negative for banks as they are in the business of borrowing on the short end of the curve and lending on the long end, the Fed's move was already largely priced-in, as the S&P/TSX Equal Weight Banks Index is down only 0.4% since the Fed announcement at 12:30pm on June 20. In comparison, the S&P/TSX Composite Index is down 2.2% over the same time period.
• From a technical perspective, the S&P/TSX Equal Weight Banks Index recently momentarily crossed above its 50-day moving average (MA), before recently retreating. The Canadian banks will look to see if it can build on its positive momentum in June, its Relative Strength Index (RSI) crossed above the 50 level while shorter-term indicators such as the Moving Average Convergence-Divergence (MACD) also confirmed positive momentum which has been building. (Chart B)

Investment Idea:

• Investors can efficiently gain access to the Canadian banks through the BMO S&P/TSX Equal Weight Banks Index ETF (ZEB), which tracks the S&P/TSX Equal Weight Banks Index. This ETF holds the big six Canadian banks using an equal weighting methodology, which is rebalanced on a semi-annual basis. Currently ZEB has a portfolio yield of 4.4%, which is slightly higher than the 4.2% dividend yield of the S&P/TSX Financial Index.
• Investors that want exposure to the Canadian banks may also consider the BMO Covered Call Canadian Banks ETF (ZWB). Similar to the ZEB, ZWB holds the big-six Canadian banks using an equal weight methodology with rebalancing on a semi-annual basis. In addition however, ZWB also utilizes a covered call overlay which involves selling call options against a portion of the portfolio to generate income. Currently ZWB has a portfolio yield of 8.0%. For more details on the mechanics behind a covered call, please see our Covered Call Option Strategy whitepaper found on our website.

Chart A: Canadian Banks Inexpensive Based on Current P/E

Chart B: Momentum in Canadian Banks Was Positive in June

All prices and yield figures as of market close June 22, 2012 unless otherwise indicated.

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Information, opinions and statistical data contained in this report were obtained or derived from sources deemed to be reliable, but BMO Asset Management Inc. does not represent that any such information, opinion or statistical data is accurate or complete and they should not be relied upon as such. Particular investments and/or trading strategies should be evaluated relative to each individual's circumstances. Individuals should seek the advice of professionals, as appropriate, regarding any particular investment.

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