There’s growing concern about the UK economy and fears that we could go into a recession early next year. As a barometer for the state of the economy, Lloyds Banking Group (LSE:LLOY) would be an interesting stock to watch in that situation. But with a good financial recovery since the pandemic and a stronger balance sheet, should I be comfortable buying Lloyds shares now ahead of a potential downturn?
Pandemic recession not a fair comparison
In the first quarter of 2020, Lloyds shares halved in value. The impact of the pandemic starting did push the UK into a recession later in the year. From that angle, the impact of a looming recession was negative for the bank and the share price.
This was a fairly unique situation. The pandemic came as a big surprise, meaning that few companies were prepared to deal with it. So I don’t think that taking into account that last recession alone is a good representation of any future performance for Lloyds shares.
By contrast, I’d say it’s fairly clear what will cause the next potential recession. High energy prices, high inflation and the cost of living crisis are the key elements here. This is a known issue already, with a bank like Lloyds very aware of it.
Some actions are out of the management team’s control. Yet other actions to bolster the bank have been taken. For example, in the Q1 results, the CET1 ratio stood at a healthy 14.1%. This ratio measures the core capital it holds against risk weighted assets. It’s a gauge of how well it could withstand financial distress.
Lloyds shares are already good value
Another angle I can consider that makes me think further downside for Lloyds shares is limited is the current value. It has a price-to-earnings ratio of 5.99, which is well below the FTSE 100 average.
As a comparison, HSBC has a ratio of 10.84 while NatWest is currently at 9.92. So even when I compare Lloyds to industry peers, it looks better value.
I’m not saying that the stock couldn’t fall further than the current price. After all, it’s down 10% over the past year, even with the pandemic largely behind us. But my thinking here is that given the state of earnings, it should act as a natural floor for the share price. Value investors would likely be interested and buy the dip if we started to see the price move lower.
Concerns are still valid
The main risk to my view that Lloyds shares are recession-proof is down to consumer behaviour. As a retail bank, Lloyds is sensitive to what people do. If spending dries up, mortgage applications fall, loans default and more, it’s not going to be a good time for the bank. Some of this could be offset by higher deposits as people save instead of spending, but this is unlikely to offset the negatives.
On balance, I think that at current levels, Lloyds shares should be able to withstand a potential recession without losing significant value. Therefore, I’d be happy to own the stock now, even with an uncertain future for the UK economy.
