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Noah Zivitz

Managing Editor, BNN Bloomberg

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Canadian bank stocks likely won't make any big moves out of bear market territory until the economic outlook becomes more clear, an analyst said.

In a report to clients Thursday, Darko Mihelic from RBC Capital Markets said the country's big lenders will likely need to shore up their credit reserves in the upcoming reporting season, and reckoned there's no imminent sign of a trigger to pull their stocks out of the current malaise.

"We think major positive catalysts (like a weak inflation print or maybe the end of the war in Ukraine) are difficult to see shorter term. That said, the unemployment rate (the most important metric) does not seem to be deteriorating either — so we think the Canadian banks stocks may generally trade range bound shorter term until there is greater clarity on the state of the economy," he wrote.

Bank stocks have been pummelled as central banks move more aggressively to tame inflation. While commercial banks benefit from higher rates as they lift interest income, an aggressive tightening cycle can also prompt concern about a recession and loan defaults by clients.

The S&P/TSX banks index (which includes the Big Six, as well as Canadian Western Bank, Laurentian Bank of Canada, Home Capital Group Inc., and EQB Inc.) recently tumbled as much as 23.5 per cent from its high in February — surpassing the 20 per cent threshold for what's commonly defined as a bear market. As of the close of trading Wednesday, the index was down 19.9 per cent since Feb. 8.

Mihelic noted that the big U.S. banks that recently reported second-quarter results built US$1.1 billion in reserves during the period, fully reversing the amount they released from reserves in the first quarter.

Based on that, and a track record of following in the footsteps of their American peers, Mihelic said he thinks the Canadian banks will, at minimum, halt releases from their reserves when they release quarterly results next month.

"Having seen some U.S. bank results, we believe the Canadian banks may also start to gradually build reserves, a sort of 'death by a thousand cuts' approach rather than getting ahead of possible credit problems with larger reserve builds," he wrote.