UK Edition
Since this column’s last look at Lloyds, it feels as if all hell has broken loose in the wake of the collapse of Silicon Valley Bank, which has stoked fears of contagion and a fresh downdraft in banking shares. However, shareholders in Lloyds should remember three things, then take a deep breath and hold on.
First, SVB took too much sector‑specific risk and was simply badly run. All banks must manage their assets (loans) so they cover their liabilities (deposits) and also manage their liabilities with sufficient caution so that those liabilities do not start to flow out of the door. SVB failed to meet these basic prerequisites, lulled into a false sense of security by years of cheap and easy money in the form of record-low interest rates and quantitative easing.
Just because SVB was an accident waiting to happen – the shares had been steadily sliding since they peaked in November 2021 – does not automatically mean other banks are in a similarly parlous position.
Second, Lloyds’ shares still trade at a discount to the bank’s net asset, or book, value of 51.9p per share, so some degree of bad news is already priced in. This is not necessarily the case with big US banks, which, with the exception of Citigroup traded at a premium before SVB went down, to leave them more exposed on the downside to any unexpected bad news.
Finally, the shares are only back to where they were in January, which is also the case with the other big FTSE 100 banks, except Barclays, which lurks at levels last seen in November.
This does not mean shareholders can be complacent, specifically with regard to banks and about markets more generally, and there are three lessons which can be drawn from the SVB debacle.
The main one is that an era of effectively free money is over. Interest rate increases from central banks the world over – 367 in 2022 and another 40 already in 2023 according to cbrates.com – are doing what they are supposed to do, which is cool down the economy and financial markets.
For markets, the mad party of 2020-21 of meme stocks, cryptocurrencies, stablecoins, jpegs of monkeys, tech stocks, Spacs, IPOs and other speculative, bubbly options is going flat and giving way to a hangover, and a potentially big one at that.
Anyone who doubts this, should look at the share price chart of Amazon, Netflix, Tesla or any other cult stock and draw a line from the share price at the start of 2020 to where it is today.
The period of 2020-2021 may have looked and felt like the new normal at the time, but as the sugar rush of cheap money wears off it is starting to look like an aberration.
For the economy, companies’ cost of capital is now higher and a return to the carefree days of zero-interest-rate-policy (Zirp) is unlikely, because of the fight against inflation. Companies whose business models relied on an artificially low cost of capital are going to struggle, if not outright fail. Those who survive may need to cut costs and they had better have well-buttressed balance sheets.
Then we come to central banks. They are trying to steer economies and markets between the Scylla of recession on one side and the Charybdis of inflation on the other.
The rally in bond and share prices from the autumn low suggested that markets had great faith in their ability to do so, as valuations began to price in an easing in the rate of inflation, a mild (if any) economic downturn and a peak in interest rates for 2023.
Matters do not look so simple now, and the outcomes look less predictable and benign. Hence the latest bout of share price volatility as expectations are recalibrated and markets – and policy-makers – accept it may not be so easy to extricate themselves from zero rates and trillions of dollars in quantitative easing without something unexpected happening somewhere along the line.
Thus, the conclusion is investors must stick to their disciplines. Egregious risk-taking feels less likely to rewarded than before. A premium may be placed on cash flow and balance sheet strength and jam‑tomorrow stocks that burn cash could find the going tougher as their cost of capital rises.
Valuation should again matter and investors may need to focus on downside protection and resist the temptation to chase share price momentum and give in to the fear of missing out.
In Questor’s view, Lloyds’ yield and valuation should help to underpin the shares.
Questor says: hold
Ticker: LLOY
Share price at close: 48.24p
Russ Mould is investment director at AJ Bell, the stockbroker
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