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The Bank of Nova Scotia building is shown in the financial district in Toronto on Tuesday, August 22, 2017. Canada's biggest banks could deliver another profitable season for investors as third-quarter results starting to roll in this week are expected to get a boost from the strengthening economy.THE CANADIAN PRESS/Nathan Denette ORG XMIT: NSD109

What needs to happen before Canadian bank stocks rally

Solid third quarter earnings and even better year-to-date results, coupled with a lacklustre share price performance so far in 2017, have Canadian bank stocks looking like pretty good value these days. That has some investors looking forward to a rally in the near future, but a few issues might need to be sorted out before that happens.

Darko Mihelic, a Toronto-based analyst at RBC Capital Markets, is among those that believe the banks are close to being “undervalued.”

However, regulatory and accounting changes, the Bank of Canada’s plans for interest rates, and a Federal investigation into sales practices at the banks, are standing in the way of bullish bets on the sector. Then, of course, there are questions about the stability of the Canadian housing market.

While real estate worries are probably the biggest overhang for bank stocks at the moment, signs are emerging that the pullback in housing prices and activity has levelled off.

RBC estimates that residential real estate-related activity could account for as much as 25 per cent of the Canadian economy, while regulatory changes over the past year should lead to slower domestic mortgage growth.

However, Mihelic isn’t worried about credit quality at the banks. Instead, he believes rate hikes and other changes, could cause an indirect hit on the Canadian economy and bank earnings. Yet he reminded clients that recent year-over-year domestic mortgage growth has remained near five per cent on average for Canada’s biggest banks – much better than anticipated.

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