Performance, Commentary & Portfolio

Fund Manager’s Review

The economic and market news flow in December, generally matched the dull winter weather. The UK economy seemed to be stagnating, with October’s Gross Domestic Product (GDP) growth slightly negative, at -0.1% compared to the previous month, and third quarter growth was revised down to zero. However, the Bank of England (BoE) voted to leave interest rates on hold at 4.75%, with only three Committee members voting for a cut. The Labour government’s first budget seems to be making the Committee’s job harder. Although the Bank of England’s latest minutes noted that “most indicators of UK near-term activity have declined”, the Committee also noted that Consumer Price Index (CPI) inflation had been “higher than previous expectations” and they expect the headline rate to rise further.

This combination of lower growth and higher inflation weighed on the equity market, which fell by just over 1%, total return. The US stock market also pulled back, though this comes at the end of a very strong year. 10- year UK government bond (gilt) yields rose to around 4.6% as bond prices also fell.

The deteriorating economy was highlighted in a weak trading statement from SThree, a provider of mostly contract workers in the IT, life sciences and other STEM (Science, Technology, Engineering and Mathematics) sectors. The company reported a particularly weak quarter ending in November, and it is now far more cautious about next year’s outlook. The worst affected countries were the UK and Germany, which reported a drop in net fees of 21% and 17% respectively. SThree has a strong record of growth over the long-term and it has a favourable exposure to STEM disciplines and flexible workers, but the business is very sensitive to changes in business confidence over the short term.

Within the stock market, many of the sector moves reflected weaker confidence and higher bond yields. Interest rate sensitive sectors like real estate and utilities underperformed, along with cyclical industries like metals & mining and several of the industrial sectors. The best performing sectors included beverages, banks and the heterogeneous travel & leisure sector.

The Net Asset Value (NAV) total return was -1.71% compared to -1.16% from the benchmark, FTSE All-Share index. Investment performance was marginally behind the benchmark index. Performance benefitted from outperformance at Dowlais, Energean and Burberry, as well as not owning the US plant hire company Ashtead, which fell sharply on weaker trading. On the other hand, the largest negative stock impact came from not owning HSBC, which was strong. Performance was also affected by the warning at SThree and share price weakness at Tate & Lyle and DCC.

There were no significant changes to the portfolio structure in December, but we continued to add to shares that looked oversold and offered an attractive risk reward profile, such as LandSec, GSK, Pets at Home, Whitbread and PZ Cussons. This was financed by trimming position sizes in WPP, Burberry, Lancashire and Haleon, which had all performed well over the previous few months.

In addition, Merchants announced a refinancing of its debt with agreement to issue £50m of 15-year financing in January to repay £42m of maturing borrowings. Colin Clark, Chairman said “The board believes borrowing is beneficial for shareholders as it can enhance longer term returns, provided the investment portfolio total return exceeds the cost of debt, albeit with the risk of higher volatility in capital returns. The new borrowing will increase the weighted average duration of drawn debt from 10.6 years to 16.4 years with the overall average cost of debt remaining at 5.1%.” 

As we look into 2025, there are challenges and opportunities for the market. The UK economy seems to be losing momentum, with the Bank of England having cut interest rates less aggressively than the US Fed or the European Central Bank, reflecting inflationary concerns. There is a growing risk the BoE is behind the curve, although at least there is the potential to significantly lower interest rates if necessary.

The outlook for the US economy (and global trade) under Donald Trump’s second presidential term is also highly uncertain, but current momentum is positive and confidence high, with the US remaining a key geography for many UK-listed companies. Several European economies and China have challenges, whilst geopolitical risk remains elevated in Ukraine, the Middle East and elsewhere.

On the positive side, the UK stock market remains modestly valued compared to its history and compared to most other markets. Within the market, there is a significant dispersion of valuations, creating many compelling opportunities for stock prickers. We are seeing an increasing number of takeover bids for UK companies, typically at large premiums, and a high level of share buy backs, as profitable companies “invest” in their own equity at depressed prices. UK authorities are waking up to the need to support the UK stock market, with potential changes to pensions regulations and ongoing reform of market listing rules incrementally helpful. In addition, political risk seems low in the UK again, really for the first time since the Brexit referendum, and stands in sharp contrast to major trading partners like France, Germany and the USA.

Whilst global stock markets continued to be dominated by the technology titans in America, the value on offer in parts of the UK stock market is remarkable. It is impossible to know what might trigger a change in investor’s focus, but we are excited about the opportunities for the UK stock market, and Merchants’ portfolio in particular, in 2025 and beyond.

Simon Gergel
10 January 2025

This is no recommendation or solicitation to buy or sell any particular security. Any security mentioned above will not necessarily be comprised in the portfolio by the time this document is disclosed or at any other subsequent date.

Awards & Ratings

The RSMR rating is designed for use by professional advisers and intermediaries as part of their advice process. This rating is not a recommendation to buy. If you need further information or are in doubt then you should consult a professional adviser.

A ranking, a rating or an award provides no indicator of future performance and is not constant over time.