I am worried about 2022. There is more than one reason for my doubts. There is Omicron, of course, and rising inflation, and linked to rising inflation is labour shortages. I have other concerns, too, relating to the geopolitical climate. What might a Russian invasion of Ukraine mean? Is it likely? And there is China. The West is imposing bans on its officials visiting the Chinese Winter Olympics, and there are fears concerning Taiwan. It is not a pretty picture.
What should investors do under such circumstances? The obvious answer to that question is to keep your nerve. Shares go up and down; a long term investment strategy might not be too concerned about short-term volatility. Even so, there is a good case to be made for chasing income in such circumstances.
Is now a good time to invest in the two companies?
The case for and against Lloyds
The case for Lloyds comes in two parts. Firstly, and before all the recent worrying news emerged, Lloyds did, in any case, look like a good bet for income investors.
Now a new argument to support investing in Lloyds has emerged. Lloyds, like all banks, will benefit from higher interest rates as they afford the opportunity to build a higher margin between saving and lending rates.
As I write, the Bank of England has announced a hike in interest rates; more will follow.
But there is a downside. It does not look like the UK economy will be as strong next year as was commonly expected a few months ago. Lloyds Banks’ fortunes are closely linked to the fortunes of the UK economy.
Then there are house prices. Lloyds thrives when the UK housing market thrives. I am not sure that the prognosis for the UK housing market is so good if interest rates are going to rise. It depends on how much they rise, of course. The Bank of England has just increased rates from an exceptionally and extraordinarily low level to a rate that is merely exceptionally low. Rates would need to rise much higher for there to be a material effect on house prices — but we can not write that possibility off.
So Lloyds is in a funny position. It will benefit from higher interest rates, providing they don’t rise too much. Then again, we have been here before. In the build-up to the 2008 crash, central banks increased interest rates from a level that was considered unusually low at that time. It did not end well.
On the other hand, the Lloyds Bank balance sheet is strong; the bank is not as vulnerable to falling house prices as it was in 2008.
The vase for BP is partly obvious and partly nuanced.
The oil price is up and may rise further. That is good for all oil companies.
But I am not as bullish as others. I believe that the current strength of the oil price is temporary. Sure the temporary situation may be a ‘long-temporary’, it could last a few years, but by mid-decade, the electrification of cars, heating, etcetera, combined with renewables, will spell problems for the oil industry. The oil industry will get disrupted.
But BP may be alright.
There is no shortage of cynics, climate change advocates who believe oil companies are evil. I am something of a climate change advocate myself, but I think the case against some oil companies, at least, is nuanced.
The current BP CEO, Bernard Looney, does, in my opinion, genuinely believe in climate change and may not disagree with my narrative above about the future of the oil industry.
Under Looney, BP is investing heavily in renewables and other future energy technologies. It is doing all the things a company taking potential disruption seriously should be doing,
Who knows whether BP as an entity is entirely in agreement with Looney, but then the company does have previous.
Under Lord Browne, CEO until 2006, BP tried to embrace alternatives to oil, it tried to re-brand itself as Beyond Petroleum. It all went wrong with the Gulf of Mexico oil spill, but I believe its forward-thinking strategy under Lord Browne indicates a company that is more culturally able to change than some of its rivals.
That is why I like BP — it should benefit from the high oil price, and dividends will probably reflect this. However, I also think it can benefit in the longer term from the renewable revolution.