The UK equity market continued its upward march in November despite generally disappointing economic data both at home and abroad. The robustness of developed world equity markets does not appear consistent with the price action in sovereign bond markets, where falling yields seem to suggest growing concern about the economic outlook and, in particular, fears of deflation across the developed world. As Economist and Broadcaster David McWilliams recently suggested,
“At the moment, the bond market is saying the future will be all low growth and low inflation. The equity market, in contrast, is saying that it’s going to be high growth and loads of earnings. Both can’t be right!”
For much of the last six months, the UK stock market seems to have been pricing in a more positive view of the economic outlook than the bond market but, in October’s dramatic sell-off, the views of the two markets seemed to become better aligned. This was only briefly the case, however, and although UK equities have recovered much of the ground lost during the correction, the yield on 10yr UK Gilts has recently fallen to new lows for the year.
We feel more sympathetic to the view of the world implied by the bond market’s behaviour. In the short-term, this makes us feel slightly nervous about the outlook for the UK stock market but we continue to believe the portfolio is appropriately positioned for a challenging future, both near-term and, most importantly, long-term. With sensible investment horizons in mind, we remain very confident about the prospect of delivering attractively positive returns to investors.
Several of the portfolio’s core holdings performed well during the month, including our tobacco and pharmaceuticals exposures. BT proved to be the most significant positive contributor to performance, however, amid speculation (confirmed by the company towards the end of the month) that it is on the verge of accelerating its mobile services plans by acquiring a mobile network operator in the UK. Whilst we were initially sceptical about this plan, after some consideration we find ourselves increasingly supportive of the prospect of an acquisition of mobile assets. The risk of not doing a deal might actually undermine BT’s current position and, if a deal were completed, the company would be well-placed to take advantage of the ‘quad-play’ opportunity, delivering combined broadband, fixed line, TV and mobile services to its customers.
Elsewhere, with the price of Crude Oil declining by a further 20% during November to its lowest levels in over four years, our lack of exposure to the Oil & Gas sector, which accounts for 12.7% of the FTSE All Share Index*, also proved beneficial to relative performance. We remain concerned that the UK oil majors, BP and Royal Dutch Shell, are over-distributing and their dividends are at risk. Their yields are high but unsustainable, in our view, and the falling oil price simply reinforces our long-held view that there are better opportunities to be found elsewhere.
Capita shares came under pressure during the month, despite a positive interim management statement (IMS) which confirmed the company remains on track to deliver an organic growth rate of at least 8% this year, with good cash conversion, robust margins and a healthy bid pipeline. We took advantage of this weakness to add to our holding. Despite the market’s negativity, we were pleased with Capita’s trading update and continue to view it as one of the best long-term compound growth companies in the UK. The market consistently underestimates Capita’s ability to generate sustainable long-term growth both organically and through value-enhancing acquisitions.
Centrica was also weak following a slightly disappointing IMS which confirmed that market conditions continue to be challenging but the company retains its commitment to real dividend growth. Royal Mail weakened as well, following its interim results which suggested that the challenging competitive environment may mean that it takes longer than previously anticipated for the company to reach its 8% EBIT margin target. In both instances, we remain confident in the long-term investment case and took the opportunity to add to the positions.
Elsewhere, we remain fundamentally attracted to the tobacco industry as a very compelling long-term investment proposition. However, the UK-listed tobacco companies look increasingly attractive to us in valuation terms, so we sold our position in Philip Morris International and added to our holdings in British American Tobacco and Imperial Tobacco.
In terms of new additions, we added Breedon Aggregates to the portfolio during November. This is a business we have known for several years and it looks well-placed to participate in and benefit from consolidation in the UK’s aggregates industry. It has a strong management team with a proven track record of creating shareholder value through sensible acquisition activity.
We added three new small unquoted positions to the portfolio during the month, in the form of Cell Medica, Genomics and Propelair.
All that remains is for all of us at Woodford Investment Management to wish you a merry Christmas and all the best for the New Year! As the esteemed economist and market commentator, Noddy Holder, likes to say, ‘It’s Christmaaaas!’
Thanks for reading.
* Source: Bloomberg as at 30 November 2014.
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.