April was a relatively strong month for equity markets, continuing the sharp recovery since December. Investors took encouragement from positive economic data in the USA and China, as well as signs that these two countries were moving closer to resolving their trade dispute. The European Union extended the deadline for Brexit, as Parliament had still not agreed the prime minister’s withdrawal bill. The UK stock market took encouragement from hopes that the UK will avoid a hard Brexit, despite strong support in opinion polls for a new Brexit party, which has been formed by former UKIP leader Nigel Farage to contest the forthcoming EU elections.

Over the month, the UK stock market produced a positive return of +2.7%, with medium sized companies outperforming larger companies. The best performing sectors included financials and cyclicals such as life insurance, financial services, construction and media, whilst several defensive sectors, such as tobacco, pharmaceuticals and electricity, produced negative returns.

The portfolio outperformed the rising market, with the Trust’s NAV rising by 4.8%. St James’s Place and Standard Life Aberdeen gave double digit returns in the month, reflecting recovering investment markets, whilst WPP was also very strong, on increased confidence in the company’s turnaround strategy. The other notable positive performance effect came from not owning AstraZeneca, which underperformed, and held back the index return. There were few significant underperformers in the portfolio, but Imperial Brands and SSE were weak, along with other defensive companies. Greene King also pulled back sharply at the month end, after a very strong rally on improved trading in its pubs and restaurants.

Our value driven investment philosophy involves a regular reassessment of companies in the portfolio, to ascertain whether we still have strong conviction in the investment case, or if we should be adjusting the position size to reflect a different view on the value opportunity or the level of risk. Having seen a wide dispersion of share price returns in recent months, we took advantage of opportunities to add to cheap companies which have lagged the wider market, where we see significant upside. We added to PZ Cussons, British American Tobacco, ITV, National Grid and National Express among others. Conversely we took money out of shares which had performed well, where we felt the upside was more limited, including Ashmore, BHP, Prudential, Legal & General and Tate & Lyle.

The stock market has recovered in the first few months of this year, erasing most of the losses in the last quarter of 2018. Despite this move, aggregate valuations of UK companies are very reasonable on a long term basis. Whilst many investors are concerned about the potential impact of Brexit on the British economy, it should be remembered that the bulk of sales and profits of UK listed companies actually comes from abroad. Many large companies, in industries ranging from oil & gas and mining to pharmaceuticals and aerospace & defence actually have limited exposure to the domestic economy.

Not only is the overall stock market reasonably valued, but there is a high dispersion of valuations. Perceived high quality or non-cyclical companies are generally trading on high valuations, whilst many other sound companies are trading at low, or in some cases, exceptionally low levels. The Merchants Trust portfolio is heavily biased towards these “value” investments and we believe that, in aggregate, these shares can deliver a combination of an above average dividend yield and a good total return, commensurate with the Trust’s objectives.