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Forget the Lloyds share price! These profit risks will make you lose sleep

Royston Wild
Road sign warning of a risk ahead

That spurt of investor buying that sent Lloyds Banking Group‘s (LSE: LLOY) share price to multi-month highs above 60p in October didn’t take long to fizzle out.

It seems that waves of stock pickers remain lukewarm, despite the FTSE 100 bank’s cheapness, as illustrated by its sub-10 forward P/E ratio of 8.1 times and its monster 5.8% dividend yield. City analysts expect earnings to dip 3% in 2020, but in my opinion there’s plenty of reason to expect a bigger reversal given the murky political and economic waters facing the UK next year and beyond.

Political problems

First off, let’s address Brexit, that unmovable elephant in the room. As I type, it looks highly likely that the Tory Party could claim a Parliamentary majority next month and lead the UK out of the EU on January 31.

This wouldn’t be great for Lloyds and its peers as Johnson’s current Brexit deal would come at an expensive cost for the domestic economy — the National Institute of Economic and Social Research says that it will shave around £70bn per year off GDP compared with if Britain preserves its current arrangements — though this isn’t the biggest thing for the banking sector to fear.

A Conservative-controlled House of Commons leaves the possibility of a no-deal withdrawal on December 31, 2020 very much in play. Prime minister Johnson has repeatedly said he’ll have a trade agreement with the EU hammered out by the end of next year, though experience shows that such deals often take years, not months, to achieve. This makes it more likely that the transition period will come to a close in 2020 without an accord in place and a disorderly exit transpiring.

On top of this, there remains much uncertainty over what any trade deal would look like and what this would mean for the UK economy over the long term. And trade negotiators need to start working on commercial arrangements with the rest of the world too, a process that also threatens to take years and lead to much more turbulence during the 2020s.

Low rates

It’s not just that Lloyds has to contend with Brexit uncertainty and the consequent economic impact well into the 2020s, however. Banks all over the world have seen their profits pressured by an environment of rock-bottom interest rates, and all indications are that central banks are set to cut their benchmarks even more.

Indeed, European Central Bank vice-president Luis de Guindos just this week said that “the recent softening of the macroeconomic growth outlook and the associated low-for-longer interest rate environment are likely to weigh further on [the banks’] profitability prospects.”

Weak growth in the UK has certainly led to speculation that the Bank of England could be slashing rates in the not-too-distant future. At the latest meeting of the bank’s Monetary Policy Committee, two of the members voted to cut interest rates, and with the latest growth data since then showing the UK economy growing at its slowest rate for nine years (just 1%), it’s possible that more policymakers will be getting on board. Don’t be surprised, then, if rates are cut either next month or at the beginning of 2020.

It’s clear that investing in Lloyds is a high-risk endeavour in spite of that low valuation. But don’t worry, there’s no shortage of brilliant dividend stocks that could help you get rich and retire early.

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Royston Wild has no position in any of the shares mentioned. The Motley Fool UK has recommended Lloyds Banking Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Motley Fool UK 2019