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There are growing concerns about the UK economy and fears that we may be in recession early next year. As a barometer of the state of the economy, Lloyds banking group (LSE:LLOY) would be an interesting stock to watch in this situation. But with a healthy financial recovery from the pandemic and a stronger balance sheet, should I be comfortable buying Lloyds shares now ahead of a potential downturn?
The pandemic recession is not a fair comparison
In the first quarter of 2020, the value of Lloyds shares halved. The impact of the onset of the pandemic pushed the UK into recession later that year. From this perspective, the impact of a looming recession has been negative for the bank and the stock price.
It was a rather peculiar situation. The pandemic came as a big surprise, which meant few companies were prepared for it. So I don’t think just taking this latest recession into account is a good representation of the future performance of Lloyds shares.
On the other hand, I would say that it is quite clear what will cause the next potential recession. High energy prices, high inflation and the cost of living crisis are the key elements. This is already a known problem, and a bank like Lloyds is very aware of it.
Some actions are beyond the control of the management team. Yet other steps to strengthen the bank have been taken. For example, in the first quarter results, the CET1 ratio was 14.1%. This ratio measures the capital base it holds against risk-weighted assets. It is a measure of how well he could withstand financial distress.
Lloyds shares are already good value
Another angle I can consider that makes me think the further decline in Lloyds shares is limited is current value. It has a price-earnings ratio of 5.99, which is well below the FTSE 100 average.
To compare, HSBC has a ratio of 10.84 while NatWest is currently at 9.92. So even when I compare Lloyds to industry peers, it seems better value for money.
I’m not saying 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 I think here that, given the state of earnings, this should act as a natural floor for the stock price. Value investors would likely be interested and buy the dip if we start to see the price drop.
Concerns are still valid
In my view, the main risk that Lloyds shares will weather the recession is consumer behavior. As a retail bank, Lloyds cares about what people do. If spending dries up, mortgage applications drop, loans go unpaid and more, it won’t be a good time for the bank. Some of that might be offset by higher deposits as people save instead of spend, but that’s unlikely to outweigh the downsides.
Overall, I believe that at current levels Lloyds shares should be able to weather a possible recession without losing significant value. Therefore, I would be happy to hold the stock now, even with an uncertain future for the UK economy.