Is Lloyds so cheap that it's become a hedge against economic downturn?

Fears over the UK housing market and a global downturn seem to be growing, are shares in Lloyds so cheap that it has become a good hedge against economic crisis.

Article updated: 26 October 2018 7:00am Author: Michael Baxter

History never repeats itself precisely. There is plenty of deja vu around at the moment, but those who are looking for precise comparisons with 2008 will be disappointed. I wonder if shares in Lloyds have been deflated because of a somewhat simplistic comparison with what happened ten years ago.

In 2008, the global economy descended into crisis, and banks were at the fore. Whether they were the cause or a symptom, the fact is banks around the world nearly collapsed. If there had been no banking bailout, unpopular though it was, I wonder how deep the collapse would have been. I suspect that even those banks that came out the other end of the subprime disaster, more or less intact, would have not survived had the UK government not bailed out Lloyds and RBS.

I am not sure that the UK government ever did extract sufficient compensation from all UK banks for the way it saved them.

This time around it is not the same

This time around it is fears relating to China, Turkey, Italy and Argentina that are spooking markets.

UK banks are so much better capitalised today than they were in 2008 — regulators have seen to that. This does not mean it is impossible for them to collapse, but it is a good deal less likely.

One similarity with 2008

In one respect, the economic backdrop to 2018 is similar to the 2008 backdrop — the US could be the catalyst. In 2008 it was subprime, today it is possible US protectionism and the economic policy of stimulating an economy that is close to full employment. This creates the risk of inflation and much higher interest rates at a time when global debt levels are already close to being unaffordable.

Investors do need to think about these very real risks.

Back to Lloyds

But Lloyds Bank is focused on the UK. The real constraint on its share price have their origins in fears over a UK housing market slowdown/crash and lingering PPI fears.

And the share price has had a torrid time — down by around a fifth from the price in January, down by more than a third since May 2015.

A superficial glance at the Lloyds share price would suggest that holding shares in the bank over the last three years was a sure fire way to lose money.

Except, of course, for dividends. Factor dividends into the equation and it’s a different story.

Investors who bought and held, while they may have nursed a paper loss from the falling capital value, would in fact have done quite nicely from dividends flowing their way.

At the current share price, dividends are currently paying out around six per cent. And that’s where the allure lies. More than £3.2 billion returned to shareholders during 2018, not bad for a bank valued at £40 billion. The share price is also trading at a PE of around 7 based on forecasts for next year.

The risks

There is a risk that has been holding back shares for some time and an emerging fear. There is perhaps an even bigger cause for concern further out.

The risk that has been holding back shares for some time relates to PPI. (As an aside, if it wasn’t for what happened in 2008 do you think banks would have suffered much lower PPI related fine? I wonder whether there is a kind of implicit assumption that banks need to be punished, behind the level of PPI related awards). PPI has only got a year to run, maybe Arnold Schwarzenegger will persuade people to make a last minute rush for more PPI related payments. However, we can say that the PPI chapter in the story of Lloyds is nearly over.

The emerging fear relates to a possible UK housing market crash/mortgage crisis. I think these dangers are real, although house prices lost any link to reality such a long time ago that I have given up predicting a crash. Lloyds would be vulnerable in such circumstances, but then to an extent, this risk is already priced into shares.

The even bigger cause for concern further out relates to the threat posed by tech. The likes of Monzo, Revolut and Starling, as well as the giant techs, in particular Google, Facebook, Amazon, Apple and Alibaba, pose a more serious long-term challenge.

The question is, are the shares in Lloyds low enough to allow for these risks?

These views are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees

Michael Baxter portrait photo
Michael Baxter

Economics Commentator

Michael is an economics, investment and technology writer, known for his entertaining style. He has previously been a full-time investor, founder of a technology company which was floated on the NASDAQ, and a director of a PR company specialising in IT.