RY, The Royal Bank.

During and before the “great recession” we were able to predict fairly accurately what the Royal would do. Also after the lows, which we caught within a dollar or two , our projections were pretty accurate (see the dozens of old entries). Then when the stock went above $52 or so we were simple amazed that the bulls would be so forgetful so fast, apparently mood-swings can be , and often are, mind-numbingly stupid. Anyway here we are and now is a good time to address the future of this stock once again. Here is the chart;

RY aug 6 2011

By clicking on it you can enlarge it.

The count shown may not be correct in every detail, but I do believe the “message” or conclusion that should be draw from it, is. First a little history and facts. This bank is by far the biggest of the Canadian banks and as such it is the “price-setter” or role model within the oligopoly. A situation that is upheld by the Canadian government in millions of different ways and that allows the Royal (and the others) to extract a monopoly rent from the public in general far beyond what would be received if their income was based on their business acumen. (this lay-of-the-land can be found in many countries so it is not unique, but Canada is probable one of the best at it). In the vernacular of the street, this is commonly referred to as “nickel and diming”, except that the amounts are much larger. Much of this is achieved by obfuscation, i.e. deliberately being unclear so the client is caught off guard.

Back in 1987 the Royal took over DS, the top investment firm. DS had no intention of being taken over, it had gone public just a year or so earlier, but it got hit hard (together with Wood Gundy and others) by the British Petroleum deal. The combination of the “bought-deal” , that had just been pioneered in Canada (by Daly Gordon ), and taking too much hay on their fork in front of the 1987 market collapse, all of a sudden made it clear that DS had insufficient capital to play the game alone. For appearances the myth that DS was taken over by the Royal was fastidiously cultivated but it soon became clear that internally DS took over the sleepy giant, with lots of capital. At the same time Canada’s  5 pillars (our version of Glass-Steagall) were dismantled and banks were free to do most everything (including mortgages that were previously in the domain of trust companies). Then we got Greenspan  with zero interest rates (starting with Long Term Capital and Y2K) and the totally unfounded belief in markets’ ability to self correct(Ayn Rand’s objectivism), combined with Keynes’ misguided economics. All of which explains the Royal’s success and why the stock increases 10-fold (interest rates alone account for about 3 to 4 of the 10X).

EW wise the stock did 5 waves up to the $62 top. An A wave down followed by an irregular B up takes the stock to the $63 level of last year. Now the C wave is in progress starting very slowly and annoyingly retracing the first wave down almost in full. We have probable almost finished 1 of 3 so after a little bounce we should be in 3 of 3 and that is when all hell breaks lose. This is also the point where many holders of the stock will begin questioning the desirability of the buy and hold model for the purpose of saving on taxes. The stock should drop to $40 (regression-to-the-mean), then $30 (4th of previous degree), then $23 (62%loss) and possible to $14 (the level of 4 of 3 of prev. degree.

To put the above in perspective, all this would do is take the stock back to where it was just 11 years ago,(So many stocks have already done that)! Fundamentally it is not that far-fetched. A rise in interest rates some day to, say 6 or 7% alone would cut the stock in half. Then we already know that their American escapades were not that profitable and , more recently, they were granted membership in the too-big-to-fail club. A dubious distinction because it ties their hands more than they would like. M&A  and trading income could drop like a stone, something that was already evident at banks around the world. And last but not least, the Canadian consumer, now indebted at a higher level than the Americans before the recession may have to tighten their belts a little and borrow less. The housing market here has kept going and going but now that we are approaching a house to income ratio above 10x ( the norm is 3x at best) only the most delusional optimist can maintain that everything here is honky-dory and that we here are immune. Simple rules of the game changes, in the world at large or here- we will catch up anyway – could have a pretty debilitating effect on what the banks can and cannot do and consequently on their income. In the US banking income as a percentage of the 500 companies income went from something like 10/15% 30 years ago to 30/40% a few years go. This is now rapidly reversing and would kill growth for many years to come.

There is only one count that I can think of that would allow the stock to stay above $40. The stock could be forming a huge triangle wave 4, the waves A and B are as shown but C would not go down as deep. It would retrace about 62% of the preceding leg, or the alternatively preceding leg; both yield the same target of $40 by coincidence the “mean” level). D and E would then follow. I would put the chances of that as rather remote, given the state of affaires in the world. Time will tell.