As is often the case over shorter time periods, April’s market movements are difficult to explain rationally.
In the US, disappointing first-quarter GDP figures were shrugged off by the market, which has perhaps concluded that slowing growth is good news because it delays the start of interest-rate tightening. Nevertheless, in a reversal of recent trends, the US dollar weakened, which led to a rally in oil and other commodities, and (in our view, somewhat premature) fears of renewed inflation led to a spike in the yields of US Treasuries and other sovereign bonds towards the end of the month. Meanwhile, a stronger euro led to a sell-off in European stock markets, which appears to have wrong-footed many short-term market participants – long European equity & short euro has become a very crowded trade. Not all of these price movements are mutually compatible, suggesting that markets have been driven more by flow than by fundamentals.
UK equity investors appeared relaxed about the general election campaign and the threat of a prolonged period of political uncertainty. The FTSE All-Share enjoyed a strong month rising +3.0%, led by commodity-related stocks. In recent weeks, the FTSE 100 has been repeatedly flirting with the 7,000 level, despite very little excitement in the way of earnings growth. As a result, there is clearly a lot of risk in certain parts of the UK market, although there are also areas where valuations remain compelling.
The portfolio delivered a solid performance in April, but trailed the wider UK stock market. Our tobacco holdings contributed positively, with Imperial Tobacco, British American Tobacco and Reynolds American all recovering from their weakness in March. This is a classic example of how sentiment can afflict share prices in the short-term, regardless of long-term fundamentals. The volatility has been caused by “will they? / won’t they?” speculation about whether the Federal Trade Commission (FTC) will approve Reynolds American’s proposed acquisition of Lorillard. The FTC’s final ruling is believed to be imminent but we have no greater insight into their thinking than anyone else. The deal, which involves Imperial Tobacco buying brands from Reynolds and Lorillard on anti-trust concerns, makes sense strategically and financially for all parties involved but, regardless of the FTC’s decision, we remain very positive on the sector given its dependability and the prospect of sustainable long-term dividend growth.
Rolls-Royce was another strong performer, as the shares rose on the appointment of Warren East, formerly head of ARM, as Chief Executive from July 2015. We are in two minds about this as we think that John Rishton, the outgoing Chief Executive, has done a pretty good job in difficult circumstances. He has taken some bold decisions to improve Rolls-Royce’s long-term operational & financial performance, which arguably should have been taken long before he took to the post. Nevertheless, Warren East has a strong reputation. The parallels between ARM, which makes semiconductor chips, and Rolls-Royce are not immediately obvious but both companies make high-quality component products where performance and reliability are critical. Furthermore, East already knows Rolls-Royce well, having served as a non-executive director since January 2014. Rolls-Royce itself has just had the biggest contract win in its history and, despite its recent growing pains, has word-class technology, a fantastic product suite and a brimming long-term order book.
Meanwhile, weakness in the US biotech sector weighed slightly on performance. A large number of US biotech stocks have been trading on bubble-like valuations, buoyed by growing excitement about new potential treatments for cancer and in other areas of high unmet clinical need, as well as by hopes of acquisitions by cash-rich pharmaceutical majors. More recently, concern about valuations has caused significant volatility across the sector, even in shares that have lagged the rally, such as Prothena and Alkermes. Here we are attracted to much more reasonable valuations, but these did not save them from the sector-wide volatility. We added to Prothena during the month.
Another notable underperformer was Spire Healthcare, where recent share price strength encouraged its previous private equity owner, Cinven, to further reduce its remaining stake. As had been the case with January’s placing, the shares immediately retreated back towards 300p, which is disappointing and suggests that most of the participants in the placing were not intending to remain on the share register for more than a few weeks. We participated in the placing and continue to view Spire as an attractive business, well positioned to benefit from structural long-term growth in the UK private hospital industry.
In terms of portfolio activity, we added to Legal & General during the month. Its shares have been weak in recent weeks, despite solid operational progress. The life insurance industry has historically been opaque and unpredictable but, with a relentless focus on cash generation, Chief Executive, Nigel Wilson, is transforming the business into a much simpler, easier to understand business with strong growth prospects. We remain attracted to the dividend yield and the prospect of attractive dividend growth in the years ahead.
Elsewhere, we added to shares that have demonstrated weakness in the run-up to the General Election, including BAE Systems, Centrica and SSE, and also topped up several other important income contributors such as of GlaxoSmithKline, Game Digital, Next and Royal Mail at what we consider to be attractive valuation levels.
Meanwhile, we were able to increase the fund’s holding in RM2 International during the month. The business is still at an early-stage of its development but has tremendous potential to disrupt the pallet industry. Although it has suffered setbacks over the past few years, its recent contract win with PPG International is very positive news, in our view, and could herald the broader adoption of its composite pallets, which are superior to wooden pallets in almost every way: lighter, more durable and more cost-effective, as well as more environmentally friendly.
In terms of disposals, we reduced the position in Roche slightly with the shares trading close to all-time highs in sterling terms. We also marginally trimmed the position in BT, where the share price is now back at levels not seen since early 2001, when Bob the Builder was at number one in the charts. Can we fix it? Without wishing to tempt fate, Ian Livingston, Gavin Patterson, Tony Chanmugam et al, we do believe that you have!
The views expressed in this article are those of the author at the date of publication and not necessarily those of Woodford Investment Management LLP. The contents of this article are not intended as investment advice and will not be updated after publication.
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The views and opinions contained herein are third party and may not necessarily represent views expressed or reflected by Willis Owen.