BMO and Interest Rates

By Malcolm Berko

December 2, 2015 5 min read

Dear Mr. Berko: What do you think of the Bank of Montreal as an investment for a 55-year-old widow who can afford moderate risks? Is the Canadian economy strong enough to support growth in this stock? And what do you think the stock market will do when the Federal Reserve raises interest rates? — LG, Bethlehem, Pa.

Dear LG: Press 1 for French, and press 2 for English!

The Bank of Montreal (BMO-$57), home-ported in Montreal and founded nearly 200 years ago, is the longest-paying dividend stock in Canada. The excellent management of this very French bank operates 1,550 branches with 47,000 employees and has produced a fine record of revenue, earnings and dividend growth. And unlike its American counterparts, BMO is a good corporate citizen; it doesn't plunder its investment accounts, pillage its borrowers, raid its credit card customers, expropriate checking account balances, maneuver commodity prices, abuse its mortgagors or corrupt currency markets. Also unlike American banks, BMO is not disparaged by its customers. The shares — trading at $57, down from $82 this year, and yielding 4.3 percent — appear to be an attractive investment. And if the dividend increases to $2.85 in 2016 as Wall Street believes it will, your purchase at $57 will look like an opportunity others wish they had taken, too.

BMO also has strong footprints in the U.S. through its acquisitions of Harris Bank, Marshall & Ilsley and Mercantile Bancorp. BMO's $700 billion in assets translates to a book value of $57.25 (fractionally above its current share price), which should help produce record share earnings in 2015 of $6.80. And going back 20 years — with the exception of the four-month period of November 2008 through February 2009 — this is the first time BMO has traded below its book value. For this and other reasons, Citigroup, Barclays and Standard & Poor's have "buy" recommendations on the stock, with a target price between $76 and $82.

However, there are others who strongly disagree. They note that the Canadian economy, with a 6.8 percent unemployment rate, is going through a significant and complex adjustment. The Canadian dollar, or the loonie, crashed to 75 cents versus the U.S. dollar. The Canadian housing market appears to be on the cusp of a bubble, while prices for commodities (zinc, copper, nickel and lead) have fallen sharply. The prices for agricultural products such as wheat, corn, soybeans and hides have dropped significantly, reducing the increase of Canada's gross domestic product to 1.2 percent in 2015 from 1.9 percent in 2014. But Canada's economic problem is mostly about oil. It's hugely worse than the Street predicted last March, when crude plunged to $44 a barrel from $107 in June 2014. Now some oil bears tell us that with Iran back in the oil exporting business, oil could fall to $30 by early 2016. When the expenses of wages, drilling equipment, storage terminals, pipelines and moving oil and then shipping byproduct via rail, tankers or trucks exceed the cost, there's going to be trouble in the oil patch. Therefore, though the consensus on BMO at Merrill Lynch, TD Securities and Thomson Reuters isn't "sell" — which is a bad word in this industry — it's "underperform," just as it is with the Canadian economy. But I still think BMO is a buy.

There have been seven Federal Reserve tightening cycles since 1982, and in six of the seven increases, the S&P 500 index was higher 12 months later. According to my genius research assistant, a retired 85-year-old certified public accountant with an eidetic memory, the S&P's performance between the Fed's first raise and the Fed's most recent raise has not been unimpressive. The S&P moved higher in those six cycles, and the average increase was 21 percent. Each of these cycles had a different duration, ranging from six months to 23 months. Of course, this was B.J., or before Janet, who won't stop yapping about what she'll do. Janet Yellen, chairwoman of the Fed, will raise rates when she feels corporate revenue, earnings and dividend growth are strong enough to accept higher borrowing costs. Therefore, we shouldn't be surprised if the S&P rises after the initial tightening, because it presages continued economic growth.

Please address your financial questions to Malcolm Berko, P.O. Box 8303, Largo, FL 33775, or email him at [email protected] To find out more about Malcolm Berko and read features by other Creators Syndicate writers and cartoonists, visit the Creators Syndicate website at www.creators.com.

Photo credit: Jeffrey Zeldman

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