Canadian bank stocks are riding high after largely shrugging off economic concerns, but analysts are starting to wonder if third-quarter results next week will test optimism around the sector.
After losing ground with the broader market in early April following U.S. President Donald Trump’s tariff announcements, the sector has been on the climb.
National Bank analyst Gabriel Dechaine said the Big Six bank stocks have outperformed the wider market by one per cent so far this year, leaving price-to-earnings valuations about 15% above the historical average. He said this raises concerns of a disconnect with wider economic trends.
“This combination is at odds with what has traditionally been a bad thing for bank stocks: weak domestic GDP growth and rising unemployment,” Dechaine said.
The contrast between Canadian and global concerns about the fallout of a trade war and bank valuations has him “neutral on the sector, at best,” as the pricing relies on an economic turnaround that is far from guaranteed.
While he’s not as confident as some investors, he also doesn’t expect any big negative swings in the third quarter.
“While the outlook remains highly uncertain and while rising Canadian unemployment bodes poorly for future credit performance, we do not believe a single event during Q3/25 would spur another period of elevated performing provisions.”
Banks raised provisions for potentially bad loans last quarter as economic risks grew, but how much they adjust provisions is generally one of the harder financial measures for analysts to peg. Dechaine said provisions remain the biggest source of forecast uncertainty for the quarter.
While banks might not see big builds in provisions, they also aren’t expected to repeat the trading gains they made last quarter.
“Fewer tailwinds this quarter suggests some downside risk,” Scotiabank analyst Mike Rizvanovic wrote in a note.
He said an improved earnings-per-share outlook for next year is a potential upside, but he doesn’t think it’s likely given moderation in capital markets earnings compared with the first half of this year.
Banks are also dealing with subdued loan growth, a gradual unwinding of provisions for bad loans, and reduced margins if interest rates fall as expected, all further challenging earnings growth ahead, he said.
Analysts say lofty bank valuations are partly based on better economic conditions forecast for fiscal 2027, where some see notable gains.
“Investors appear to be getting more comfortable with the risk level and are looking through near-term challenges into F2027,” CIBC analyst Paul Holden said.
Holden has released his own first estimates for fiscal 2027, predicting earnings per share could be up 14% by then, while return on equity could reach 14.2%, compared with an estimated 13.6% for fiscal 2026.
For the third quarter, he expects a small uptick in impaired loans, where banks are less confident about repayment, while provisions for performing loans, where there is less concern, should stay stable.
BMO and Scotiabank report results next Tuesday, followed by Royal Bank and National Bank on Wednesday. CIBC and TD Bank Group round out results on Thursday.