The big UK macroeconomic bet
What’s the shape of this recession going to be then? The V shape that we’ve had so far? That is, an horrendous slump in GDP of 20% and more followed by clawing back half of that in the subsequent three months? Presumably to be followed by another climb in the month just gone and the month currently we’re living through? That is what has happened in the UK so far, yes.
But is it going to continue? What about when furlough ends – in a few weeks that is – are there going to be millions unemployed? Some less than reliable commentators seem to think unemployment could soar to 6 million. Near everyone agrees that it’s going to go up from its current rate of 4% or so. But how much?
Are we going to have a W shape to the recovery? Hey, maybe the recent rises have just been reopening and the economy is so damaged that we’ll slump back to that horrendous loss again and stay there?
Agreed, and as above, that’s not what I think will happen. I think we’re going to have the occasional slip and slide, certainly, but most of the GDP loss will be made back swiftly then we’ll have a more difficult period of adaptation to a socially distanced economy. That last 5% – just to give a round number – of the recovery is going to take more time.
So, that’s all opinion. How do we trade this?
The banking system
The UK banking system is how we trade this. The European banks tend to be financiers of industry rather than households. Tend note, not exclusively. In the US mortgages – by far the largest part of household borrowing – tend to be financed by markets. Bond issues and the likes with banks not holding the book even if they might arrange it.
In the UK banks are a small part of industry financing, near anything at scale is financed through the public markets as in the US. Given the problems Northern Rock had there’s nowhere near as much market financing of the mortgage market, that does tend to remain on the books of the banks. So, mortgage risk, property market risk, is heavily concentrated in the banking system.
So, if we’re thinking that there might be, as a long term outcome of the coronavirus, a meltdown in the housing market banks are where it is going to be traded. If the rebound stutters significantly, if we get mass unemployment as a result of it all in the near future then there will be that housing market recoking. So, banks are where to trade a view of the success or not of the recovery.
Lloyds Bank (NYSE:LYG)
If it’s the economy as a whole that we want to trade via that housing market then we need a bank which is as close as we can get to a play on that very housing market. RBS is still so government owned that it’s not going to trade all that far down if disaster strikes. HSBC has that vast Far East business. Barclays still has that sgnificant investment bank operation and so on. Lloyds is therefore our choice.
As The Times points out:
…the share price of Lloyds Banking Group, Britain’s biggest mortgage lender by a country mile, is on the floor because investors are so worried about a possible surge in defaults and loan losses.
They’re the biggest player in the market.
Languishing below 26p at one point yesterday, the “Black Horse” bank has disappeared through the barn floor. For most of the past five years, it has been at more than double this level — mostly bobbing around 50p to 70p. Even in the depths of the banking crisis in March 2009, the shares never fell as low as 26p.
The shares are significantly depressed given that worry about that housing market. Sure, there are other things as well. Low interest rates reduce the margins that can be made on any sort of borrowing and so on. But worries over the housing market are indeed the greatest influence upon that share price.
Yet it is still the gigantic home loan book that dominates at Lloyds and its Halifax offshoot and inevitably makes it sensitive to housing market gloom or cheer. It has £267 billion of outstanding home loans.
Yes, of course there’s more to a bank than simply this. But we don’t need to go examining the books here. The rest of the accounts just aren’t what interests us here. Lloyds is 97% focused on the UK market so that’s our geographic market sorted. It’s the largest mortgage supplier, so that’s the sector dealt with.
The stock is already depressed on worries of an imminent, or at least coming, housing market slump.
So, what if there’s no slump?
Well, if we think there’s not going to be a second slump then we can be reasonably certain that there’s not going to be a housing collapse. At which point the mortgage book at Lloyds stays good and the share price will recover.
Further, banks are leveraged to the economic cycle. Just as miners are to the price of the metal, as oil companies are to the crude price. So, the absence of that second recession will produce a significant rise in the stock price.
Further, given that so little of the UK’s housing finance is done through the public markets there’s no real other way to trade this position. It’s not possible, largely because the bonds don’t exist, to repeat the Big Short of 2007 and so on.
As I’ve long been saying I think we’re going to have that fairly rapid recovery from the coronavirus recession. I don’t think it will be complete, in that we’ve got some recalculation to do as well as simple recovery but I do not think that we’re going to have a second slump.
That could be wrong of course, maybe that mass unemployment is about to happen.
But if it doesn’t then the housing market won’t slump and Lloyds looks good.
The investor view
The case for Lloyds is that there won’t be a housing market slump. The stock price currently reflects that there might be. So, the absence of a second GDP slump, the absence of the unemployment wave, should boost the Lloyds price.
If you agree with the macroeconomic analysis then Lloyds is a way to trade that belief. Of course, if you don’t, if you think that the mass unemployment is just about to arrive then Lloyds already rather reflects that and can’t be used to trade the downside.
A medium term speculation on the state of the economic recovery therefore. The fewer problems you think the recovery will have the better Lloyds looks.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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