The last time I wrote about Lloyds Banking Group (LSE: LLOY) a couple of weeks ago, I wondered if its share price might fall below 40p. The broader markets were in a challenged spot, as bad news from Asia sent tremors across the globe. My sense was that if the stock markets did remain shaken, then the FTSE 100 stock’s fortunes could indeed continue to nosedive.
The Lloyds Bank share price rises
However, the situation has stabilised since. After falling below the 7,000 mark when I wrote the article, the FTSE 100 has inched up above that level once again. And the Lloyds Bank share price has been recovering too. Since then, its share price has gained over 7%. In fact, if I can ignore the short-term fluctuations, it is evident that over a longer time period it has made much progress. It is up by almost 70% over the past year!
This is great. But I would buy the stock only if it can continue to grow. I think there are both arguments for and against this happening. First, let us look at the bright side.
Fuelled by the economy
In my view, the biggest positive going for Lloyds Bank right now is the recovery in the UK economy. Higher growth encourages demand for loans, interest on which is essentially what earns revenue for banks. As a UK-centric bank, this gives Lloyds an edge over many of its peers that have far more globalised operations like HSBC and Barclays.
In 2021, economic growth is expected to average 6.8% as per numbers from independent forecasters compiled by the government. And even though this can be chalked up to a base effect, as the economy shrank last year, we can still take heart from the fact that growth is expected to be robust even in 2022.
An upgraded outlook and improving conditions are already visible in the bank’s results. It reported post-tax profits during the first half of 2021, after clocking a loss during the same time last year. There has also been a small improvement in loans to customers. It has even started paying a dividend, though its yield is nowhere near where it was before Covid-19.
At present it stands at 2.8%, which is a fair bit of decline from the 4.5% average yield over the last five years. And it is significantly lower than the double-digit yields seen before the pandemic. But it could move higher if the bank’s numbers get stronger and the regulators relax restrictions on payouts.
Diversifying into real estate
And Lloyds Bank is not content with just being a traditional bank either. It recently decided to foray into real estate rentals through the creation of a separate entity called Citra Living. This is a far cry from its banking operations, but there are synergies here. Lloyds Bank is, after all, the UK’s biggest mortgage lender. Citra Living has even entered into a strategic partnership with the FTSE 100 house builder Barratt Developments to develop a stock of housing that will provide affordable rentals.
It remains to be seen how well the initiative works out. The stamp duty holiday and help-to-buy initiatives are indicative of the demand for housing in the UK. In fact, as per Lloyds Bank numbers, one in five UK households is a private renter. And while it believes that rental demand is expected to rise, supply could be impacted as landlords quit the market because of regulation and taxes. And that is where it can step in.
Beating inflation with banking stocks?
To some extent, it could also be a nice stock to hold in my portfolio at a time of rising inflation. The UK’s inflation just touched 3%, which is beyond the Bank of England’s comfort level of 2%. Unlike some other segments like grocers or non-essential retailers, which may not be able to pass on higher inflation to customers, bank interest rates can rise in line with policy interest rates.
The big challenge, however, is when inflation rises and no or little growth occurs, which is a phenomenon called stagflation. Raising interest rates at a time when demand for credit is already low can be counterproductive. While we are not in that situation yet, it cannot be ruled out either. The latest monthly data for the UK economy showed that growth stalled in July. I would not read too much meaning into a single month’s numbers, but because of it, I will look out for the next release due next week. If it continues to show weakness, that could be a red flag for the likes of Lloyds Bank.
Slowing recovery is bad news for the stock markets
This is particularly so, since recent indications from China are not encouraging. Property developer Evergrande’s near collapse signalled the risks resulting from high indebtedness. I reckon this is educational for not just the country, but across economies fuelled by easy monetary policies and high public spending that may not be sustainable. Banks can be particularly vulnerable to adverse developments when the cracks begin to show, as they can suffer from bad debts.
The stock markets have already had an adverse reaction to this. It contributed to a fall in the FTSE 100 index in September from the month before. And while the markets have settled down in recent days, stimulus withdrawals can still impact them.
In the UK, the withdrawal of the stamp duty holiday and the furlough scheme could also tell on growth numbers in the next few months, besides just having a sentiment-driven impact on the markets. This could keep them moving sideways, which is not exactly the ideal condition for individual stocks to thrive, especially not cyclical ones like banks. In any case, withdrawal of housing market related stimulus is a negative for Lloyds Bank, because it is a big lender for property loans.
Can Lloyds Bank continue to soar?
Based on the mounting risks to financial markets, I think it is reasonable to expect that the FTSE 100 index is unlikely to rally the way it has over the past year. This means, that the Lloyds Bank share price will not have broad-based support from stock markets.
However, its own prospects look better than they did last year. If its results continue to be sound and it also increases its dividends, I reckon there is a case to buy it. So while my outlook on the stock is more positive than when I wrote about it last, I will hold off on the purchase for now, and wait and watch how things unfold instead.
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Manika Premsingh has no position in any of the shares mentioned. The Motley Fool UK has recommended Barclays, HSBC Holdings, and Lloyds Banking Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.