The Canadian banks have been getting a lot of attention lately. Last October, the World Economic Forum rated them the best in the world, ahead of Sweden, Luxembourg and Australia.

Compared with their basket-case brethren in the U.S., they look positively healthy. They never took on excessive mortgage risk, as Canada was never awash with subprime mortgages or securitization of the loans after the fact. Things like "no documentation of income" never flew in Canada, where bankers have always tended to be pretty bankerish, generally demanding 20% down.

The Canadian economy hasn't been prone to economic booms and busts like the U.S.' Equities never went up as much in the dot-com heyday, and home prices increased over the last few years, but not like the overheated U.S. markets. Also, Canadians never had the same wealth created (or credit available to them) over the past few years to allow a large number of families to buy second, third and fourth investment properties to the extent that happened in the U.S..

So as the banks around the world have imploded, the six largest Canadian banks: Royal Bank of Canada ( RY), Bank of Nova Scotia ( BNS), Toronto Dominion Bank ( TD), Bank of Montreal ( BMO), Canadian Imperial Bank of Commerce ( CM), and National Bank of Canada (TSE) -- have looked like stalwarts.

Most are still reporting earnings, have relatively low exposure to U.S. loans, and are in strong capital positions to expand their market positions globally as others wilt.

So, the question is why haven't these banks' stocks done even better over the last few months. The five U.S.-traded Canadian banks have all lost over half their value in the last year. They've certainly done better than Citigroup ( C) and Bank of America ( BAC), but that stock performance is only roughly in line or worse than JPMorgan Chase ( JPM). Shouldn't these stocks be doing appreciably better, if the banks are that much stronger?

I think the management teams and boards of the Canadian banks should be congratulated for managing their businesses so well, especially when compared to the greed and recklessness that their global competitors were operating under. I believe the market's discounting of the Canadian banks stock prices in the past year is not a reflection of what they've done, but concern over what's ahead.

The biggest concern facing Canadian banks is the future health of the Canadian economy. Although Canada rode the oil and resource boom through last June to low unemployment and a booming dollar (which at its peak was worth C$1.10 for every US $1), and many in Canada assumed that the country was "decoupled" from the problems afflicting the U.S. even as late as last September, we now know that the northern economy is tightly connected to the U.S. and world economies.

In the '80s and '90s, Canada consistently and stubbornly hung on to a higher unemployment rate than the U.S. Canadian workers have been less mobile than their American counterparts, and retraining certain swaths of society has been difficult. In the last major downturn or the early '90s, the spread between Canada and U.S. unemployment grew to over 4%.

What's more, this gap remained at these levels until 1998, when the gap started to close to only about 2% by 2002 and recently closed entirely as the U.S. rate started to tick up before Canada's did.

Quite simply, Canada lags the U.S. when it goes into an economic slowdown and takes longer to come out of it. Despite the resource boom, a large part of Canada's economy remains tied to manufacturing and shipping those goods to the U.S. A weaker Canadian dollar for much of the last decade gave these Canadian manufacturers a big advantage sending goods to the U.S. As the Canadian dollar rose to parity with the U.S. dollar in the last 18 months, that cost advantage went away, but oil, resources and the Canadian economy remained healthy.

Now, six months after Lehman collapsed and the world economy has gone into free fall, the Canadian economy is hurting. In January, the Canadian economy lost 129,000 jobs and saw its unemployment rise 0.6% to 7.2%. That same month, the U.S. economy lost more than 500,000 jobs and saw its unemployment rate climb 0.4% to 7.6%.

The rate of job loss is rising faster in Canada, and remember that Canada is 10% the size of the U.S. Imagine if the U.S. Department of Labor had announced the American economy had dropped 1.3 million jobs in the month of January, and you understand what is going on north of the border.

We know the U.S. unemployment rate is now up to 8.1% through February, but the Canadian government has yet to provide comparative data. You can expect the job losses to continue to pile up over the coming months. If the U.S. finally tops out at 10%-11% unemployment next year, as many economists call for, it is not unreasonable to expect Canada to go back to its 4% spread of 14%-15% unemployment. It is this scenario that worries Canadian bank investors and the banks' potential future losses on credit cards, auto loans and mortgages (both consumer and commercial).

There are silver linings for the Canadian economy and its banks. The Canadian dollar has already dropped to being worth US 80 cents and it could go lower, which helps Canadian manufacturers compete against U.S. companies for jobs. Canadian consumer indebtedness is healthier than in the U.S., which hopefully contributes to continued spending in the domestic economy. The Canadian government has also done little to stimulate the economy and is in a strong fiscal position to do so, if needed.

The Canadian banks are in a strong capital position to weather the coming storm and will certainly use that strength to expand into the U.S. opportunistically at some point in the next three years. But investors might choose to wait on buying these "soundest banks in the world" until they better understand how long and how deep the recession will last in Canada.

At the time of publication, Jackson had no positions in stocks mentioned.

Eric Jackson is founder and president of Ironfire Capital and the general partner and investment manager of Ironfire Capital US Fund LP and Ironfire Capital International Fund, Ltd.

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