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After a positive Q1 update, will Lloyds’ share price end its penny stock status?

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When it comes to stocks favored by private investors, Lloyds banking group (LSE: LLOY) is one step ahead of the rest. A quick look at the share register shows that over 80% of the total number of shareholders hold less than 1,000 shares. Indeed, people with less than 10,000 shares bring that figure to 97.26%.

However, such loyalty shown by its army of private investors has been misplaced. Over the past 10 years, on a return-adjusted basis, for every pound invested, the return was 52p. Even on a nominal basis the return was only 70p.

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But as net interest income begins to rise, some are hoping Lloyds’ share price could rise sharply. So, is it finally time for me to buy?

Cautious optimism

In its first quarter statement, Lloyds reported a 12% increase in total revenue compared to the same period in 2021. Operating costs also recorded a 2% reduction. However, despite these positive figures, underlying operating profit fell 7% to £1.8 billion.

Driving the reduction was a net impairment charge of £177m, compared to a net credit of £360m in the first quarter of 2021.

Loans and advances to customers increased by £3.2 billion in the quarter. This reflects strong growth in the open mortgage portfolio of £1.7 billion. The bank also saw customer deposit inflows increase by £4.8bn.

The group saw good organic growth in its insurance and wealth management division, with £2bn of new money under management.

The calm before the storm

In light of this strong financial performance, management has improved its guidance for 2022. It now expects the net interest margin to be above 270 basis points (or 2.7%). Return on tangible equity is expected to be above 11%.

However, storm clouds are gathering. Although lower than expected, a net writedown of £177m is the key metric for any investor.

The bank raised its economic forecast for 2022 based on the fact that rising inflation is offset by soaring house prices and low unemployment. However, I am not convinced.

House price inflation remains strong, but for how long? The cost of living crisis, I believe, has a long way to go. There is no indication that energy and food prices have peaked. This will eventually fuel the mortgage market. First-time buyers, who represent around a quarter of the market, will find it difficult to raise the deposit necessary to secure their first home.

I also remain concerned about the historically low unemployment rate. First, very few companies do well in highly inflationary environments. Second, there is a significant lag between aggressive fiscal policy and low unemployment. Normally, one would expect to see high levels of public debt only during a downturn.

Would I buy Lloyds?

So, would I buy? The short answer is no. I believe the business cycle is turning. Recession indicators are piling up, including rising bond yields.

My fear is that we are headed for a 1970s-style stagflationary environment. This is characterized by spiraling wage prices, low growth and runaway inflation. Such decor is the worst cocktail for any bank. For Lloyds’ business model, primarily based on mortgages, credit cards and commercial banks, this could be bad news. I expect a penny stock to remain for some time.