Despite a recent share price uptick at Lloyds Banking Group (LSE: LLOY), shares in the financial institution still remain at a 14% discount to levels enjoyed at the start of 2016.
But should recent strength prompt investors to ride the momentum train? Encourage those pessimistic over the UK economy in 2017 to sell out? Or prompt unsure investors to hang tough?
Glee not gloom
It’s no coincidence that Lloyds’ steady upswing to five-and-a-half-month highs has accompanied a slew of positive financial updates in recent months. From the Office for Budget Responsibility to the OECD, brokers across the world have been busy upgrading their 2016 growth forecasts as economic indicators haven’t — as was widely predicted — collapsed following June’s referendum.
Quite clearly those prophesising financial Armageddon have proved to be embarrassingly incorrect. And so many investors are clearly happy to treat forecasts for 2017 and beyond with more than a smattering of contempt.
But hang on…
A word of caution however. The full implications of Britain’s vote to exit the EU was always likely to be felt in the medium-to-long-term. Therefore the economy’s s resilient performance since the summer can be viewed of something of a red herring.
So in my opinion, investors will be foolish to disregard predictions of falling business investment, rising unemployment or rocketing inflation looking down the line.
The CPI gauge, for example, shot to 0.9% in October from 0.3% at the start of the year, and is expected to explode in 2017 as sterling continues its heady descent. And this item alone threatens to derail consumer confidence and with it economic expansion from next year.
Many economists have suggested that a period of rising inflation may be positive for the likes of Lloyds however, as it could lead to the Bank of England finally raising the benchmark rate. Profits across the banking sector have long been pressured by a backcloth of rock-bottom interest rates.
But investors shouldn’t hold their breath waiting on such action. Indeed, Bank of England chief economist Andy Haldane warned late last month against interest rates being raised in 2017, advising that recent economic growth and rising inflation “now leaves me comfortable with the current stance of monetary policy, with no bias on the direction of the next move in interest rates.”
True value?
Still, many stock pickers are being tempted to take a punt on the Black Horse Bank on the back of its ultra-cheap valuations.
For 2017 Lloyds deals on a P/E ratio of 9.4 times, not only well beneath the FTSE 100 prospective average of 15 times but also that of many of its peers — Barclays, RBS and HSBC all deal on multiples of 12 times, 13.1 times and 13.4 times respectively.
Furthermore, a 6% dividend yield for next year also trumps the equivalents of its banking sector rivals, not to mention most of the Footsie.
Having said that, I believe investors should give scant regard to these figures. Not only does the prospect of a dragging UK economy put these readings in jeopardy, but rising financial penalties overshadow the potential of cost-cutting elsewhere and with it the possibility of hefty dividend hikes.
I reckon the risks circulating Lloyds make it a strong sell candidate despite these low valuations.