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Even the soaring Lloyds (LSE: LLOY) share price was bound to come back down to earth at some point. And yesterday (5 February) it did just that, plunging 5.6%. What’s going on?
The FTSE 100 bank has had a terrific run. Even after that one-day drop, its stock is up 70% over the last year and more than 150% over two. I’ve had a brilliant ride myself, especially once reinvested dividends are factored in. I knew it wouldn’t last forever, but yesterday’s drop still took me by surprise.
The trigger seems to be the Bank of England’s decision to hold base rates at 3.75%. That sounds an unlikely catalyst. Rates didn’t move, after all. But the vote was close, with its monetary policy committee split 5 to 4. More importantly, governor Andrew Bailey said evidence in favour of a future cut is “increasing”.
FTSE 100 banks all fall
That’s good news for many businesses, but not banks. Higher interest rates have allowed lenders to widen net interest margins, the gap between what they charge borrowers and pay savers. That’s been a major driver of banking profitability in recent years. Now the trend may reverse. Still, the stock drop felt steep for such incremental news. But with the UK economy slowing, the housing market idling and unemployment rising, there are other things to worry about too. Especially for Lloyds, which is primarily focused on the domestic UK market.
NatWest Group, which is similarly UK-centric, fared even worse falling 6.02% yesterday. Barclays and HSBC Holdings, with their greater international exposure, dropped a more modest 3.48% and 2.29%, respectively. But lower rates remain a sector-wide worry.
Today, Halifax reported a modest 1% rise in house prices over the last 12 months, and warned that affordability remains a challenge for many buyers. While mortgage rate cuts should help, this may not be enough to offset the pressure on margins.
Downgraded stock target
It probably didn’t help that on Tuesday, Shore Capital downgraded Lloyds from Hold to Sell, arguing that its strong run has left the shares fully valued. The broker did lift its price target from 84p to 91p, but that’s still below today’s 106p.
It also warned Lloyds may struggle to sustain its return on tangible equity in the long term, citing competitive pressure and the risk of further windfall taxes if recent “supernormal” returns persist. The big banks escaped an extra charge in November’s Budget, but the threat hasn’t gone away.
Despite the wobble, Lloyds is trading at roughly the same level as a week ago. With a price-to-earnings ratio of 15.1, it’s neither expensive nor a screaming bargain. The yield has slipped to 3.43%, but with the board recently increasing the interim dividend by 15%, we can expect this to climb over time.
There’s no way I’m selling. I plan to hold Lloyds for decades and reinvest every dividend to let compounding do its work. But after running red hot, I expect the shares to cool. New investors may want to wait for a dip, and only consider buying with a longer-term view. Recent extreme excitement may be over for now.
