Investor sentiment was positive in early January, as the US and China moved towards a limited trade agreement in the middle of the month. Survey data and comments from companies suggested improving trading conditions in certain domestic industries, such as housebuilding and commercial property, in the wake of the Conservative general election victory in December. However, the positive investor sentiment was short lived as the outbreak of the coronavirus spread rapidly in China. By the end of January it had claimed over 200 lives and led to the lock-down of several large cities affecting tens of millions of people. Apart from the tragic human cost, markets reacted to the possible economic cost in terms of slower growth and restricted travel and trade.

The UK stock market fell in the second half of the month with a drop of over 3% for January. Bond yields also declined as economic growth expectations came down. The best performing sectors were generally defensive sectors, such as tobacco and utilities, although housebuilders were also strong. The biggest falls were mostly seen in cyclical industries such as oil and mining, as commodity prices fell, with banks, retail and travel & leisure also weak.

The Trust’s NAV fell by 1.8% in January, but ended the month ahead of the benchmark which fell 3.3% as the portfolio outperformed the falling market. The biggest contribution to this outperformance came from BAE Systems as the stock market reacted enthusiastically to two acquisitions it made of high technology defence businesses in the USA. Pennon shares also rallied as press articles suggested it had been offered a high price for its Viridor waste and recycling business and Keller continued its recent share price recovery. There were fewer negative contributors, but shopping centre owner Hammerson’s shares fell back as its peer Intu continued to have financial troubles, and many retailers reported poor Christmas sales. WPP shares were also weak, but on little news. Not owning Unilever also held back relative performance as the shares outperformed in a more defensive market environment.

We added the UK’s 5^th largest housebuilder, Redrow, to the portfolio, increasing the portfolio’s exposure to this sector. Redrow builds over 6,000 homes in England and Wales each year and has a strong record of growth and the shares were trading at a modest valuation. Although Redrow’s shares and the housebuilding sector generally have performed well in recent weeks, and especially since the election, we see prospects for the industry remaining good. There is a structurally constrained supply of housing in the UK but plenty of new land available due to changes in the planning system. Consumer demand is strong and seems to be improving. The government remains committed to supporting the sector and we would expect a new scheme to replace the current Help-to-Buy scheme for first time buyers once the current scheme ends. We partly funded the investment by reducing the shareholding in Vistry (formerly Bovis Homes) to diversify the sector exposure. Vistry shares have performed exceptionally well especially since its fundraising in November which we supported.

We sold the investment in industrial property company Hansteen in January as the shares were fully valued after the company received a takeover bid last year. Elsewhere, we took some profits in strong performers like Pennon and Meggitt to fund additions in more attractively priced businesses like WPP, Royal Bank of Scotland and SSE.

The Merchants Trust financial year ended at the end of January. The stock market and the portfolio have performed well over the last 12 months and the UK stock market is now close to its long-term average valuation. However, UK shares remain cheaper than most other markets and there is still a sharp polarisation of valuations across different sectors. We continue to find many strong businesses offering above average dividend yields that we can buy on attractive valuations. Our portfolio is differentiated from the overall stock market and we believe that it can continue to offer the combination of a high and rising dividend together with long term capital growth in line with Merchants’ objectives.