It’s chastening to think buyers of Lloyds (LSE: LLOY) shares at 60-odd or 70-odd pence, when the UK was emerging from recession in the second half of 2009, have seen no reward a decade later.
The shares are currently sub-60p and even with 12.8p of dividends, those buyers have seen the real value of their investment decline after 10 years of inflation. And let’s quickly pass over the destruction of wealth suffered by holders who bought in the decades before the 2008/9 recession.
As the saying goes, “the stock market is forward looking.” Will long-term investors in Lloyds at today’s share price enjoy better returns than their predecessors? Or is the stock a value trap?
Macro matters
I think it’s worth paying some attention to the macro environment when looking at companies in the most cyclical industries, such as banks. Their profits (and dividends) are highly geared to the expansions and contractions of the economy.
The table below lists UK recessions since World War II.
|
Year/s |
Duration |
Real GDP growth reduction per quarter |
|
1956 |
2 quarters |
-0.2%, -0.1% |
|
1961 |
2 quarters |
-0.5%, -0.2% |
|
1973/74 |
3 quarters |
-1.0%, -0.4%, -2.7% |
|
1975 |
2 quarters |
-0.7%, -1.3% |
|
1980/81 |
5 quarters |
-1.7%, -2.0%, -0.2%, -1.0%, -0.3% |
|
1990/91 |
5 quarters |
-1.1%, -0.4%, -0.3%, -0.2%, -0.3% |
|
2008/09 |
5 quarters |
-0.2%, -1.7%, -2.2%, -1.8%, -0.3% |
Source: Wikipedia
As you can see, recessions occur quite frequently. It would be foolish to try to predict the timing of the next, particularly after the stimulus of the Great Financial Experiment — namely, quantitative easing and low interest rates on a scale never before seen in history. But there are some things we know for certain.
What we know
Buyers of Lloyds’ shares today are 10 years nearer the next recession than those who bought when we emerged from the last one. We also know the Great Financial Experiment has encouraged a massive borrowing binge by consumers and companies.
The Bank of England recently reported that total consumer debt — credit cards, overdrafts, personal loans and car finance (but excluding mortgages) — recently hit a new all-time high of £217bn.
Meanwhile, the Bank for International Settlements has warned of the dramatic rise in borrowing by businesses with low credit scores, citing the US and UK as the worst offenders. In short, many consumers and companies are direly placed to service their debts, or repay lenders, in the event of an economic slump.
Lloyds’ prospects
Warren Buffett wrote in 2008:“You only learn who has been swimming naked when the tide goes out — and what we are witnessing at some of our largest financial institutions is an ugly sight.”
I suspect the next recession will show Lloyds as a relatively conservative lender. I see a greater likelihood of miscalculations or underestimations of risk by the challenger banks, which have been expanding aggressively, and other newcomers such as peer-to-peer lenders.
However, after a decade-long market of highly ‘competitive’ lending (lower return and/or higher risk for the lender), the Black Horse has had to dance while the music’s played. It would be naive to think it wouldn’t suffer in a recession, particularly with the record level of consumer debt and 484,000 UK businesses (14%) currently “in significant financial distress,” according to insolvency firm Begbies Traynor.
Fans of Lloyds suggest its valuation metrics of 1.1 times tangible net asset value, 7.4 times forecast earnings, and prospective dividend yield of 6%, offer a wide margin of safety.
However, much the same was said before the 2008/09 recession. On balance, I’m inclined to avoid the stock as a potential value trap at this stage of the economic cycle.
