Merchants Trust: markets are partying like it’s 1999!

Extreme polarisation of UK stock market from low interest rates, Brexit uncertainty and trade war fears reminds Merchants Trust fund manager Simon Gergel of dotcom bubble before it burst.

Merchants Trust (MRCH) fund manager Simon Gergel has warned that the extreme polarisation of the UK stock market brought on by low interest rates, Brexit uncertainty and trade war fears reminds him of the dotcom bubble at the end of the last century.

Gergel, who began his City career in 1987 and who has run the UK equity income trust for 13 years, said investors were pouring money into large, defensive, international companies in the pharmaceutical, consumer goods and drinks sectors at the expense of more lowly-rated, but better-value domestic stocks such as utilities, banks and property companies.

While this is not a new complaint of value investors, such as Gergel – who buy stocks when they are cheap and out of favour – the manager said the divergence between ‘high quality’ ‘growth’ and economically exposed ‘cyclicals’ had widened to dangerous levels.

He said the market split had been exacerbated by passive, index-tracking funds which rewarded shares that had done well by pumping them even higher.

‘It is reminiscent of the technology, media and telecommunications (TMT) bubble at the end of the 1990s. In that period companies like Vodafone, BT, Dixons, and many others were seen as high growth businesses as they enabled consumers to access the emerging internet.

‘These companies traded on extremely high valuations, whilst much of the rest of the stock market, known as "old economy" stocks languished with few buyers,’ he said.

The bubble burst in early 2000 and led to a damaging crash and three-year bear market that only was only dispelled by the US invasion of Iraq in 2003.

‘Inflated expectations could not be met by profits growth, and there was a huge rotation back towards better value companies in the early 2000s. Even a company like Amazon, which was one of the true winners and has grown into a phenomenal business, saw its share price sink by over 90% during the TMT crash,’ recalled Gergel.

‘Many other TMT shares collapsed and, even if they survived, never recovered previous levels,’ he added.

‘Perhaps the extremes today are not at the same level as in that period, but much of the market is partying like it’s 1999,’ continued the manager, in reference to the end-of-millenium hit of Prince.

‘We are not going to chase the most fashionable companies if we cannot make a sensible valuation argument for investing in them,’ Gergel told Merchants’ investors in its half-year report.

Predicting when the situation would improve was difficult but a lifting of trade and Brexit concerns would help, he said. ‘This could quickly reverse sentiment and make investors more willing to look at less defensive, but much cheaper shares.’

Referring to last month’s bid for pub and brewing group Greene King, which he held, Gergel said: ‘We are also seeing rising interest in some depressed UK stocks from private equity or corporate buyers, who ironically seem to be taking a longer term view than many market participants.’

Dividend hero

The interim results showed the highly-geared but high-yielding £536 million fund lagged the UK stock market in the six months to 31 July as value stocks remained out of favour. The net asset value (NAV) of Merchants’ investments rose 4.6% to 493.2p per share, below the 8.1% advance in the FTSE All-Share. With dividends included total returns were 7.4% although that was also below the 10.6% total return from the index.

This continues a longer trend that has seen the shares generate a 150% return over 10 years, ahead of the All-Share’s 117% but below the 198% average return of UK equity income trusts.

Merchants does better as an income provider. The trust is a ‘Dividend Hero’ of the Association of Investment Companies, having grown its quarterly pay-outs for 37 years in a row. Half-year dividends rose 4.7% to 13.5p, backed by earnings of 16.1p per share, up 3.2% on a year ago, helped by refinancings that have cut the costs of its large borrowings. 

Merchants had £111 million of borrowing, making it 19.5% geared at the half-year end. Its shares yield 5.5%, one of the highest in its sector.

The results showed Gergel had been busy, adding Imperial Leather soap maker PZ Cussons (PZC), car dealer Inchcape (INCH) and Stock Spirits (STCK), the London-listed distributor of vodka, rum and brandy in central and eastern Europe.

He sold emerging markets fund manager Ashmore (ASHM) after a recovery, grabbed the takeover offer for satellite operator Inmarsat (ISA) and dumped Marks & Spencer (MKS) after changing his view of its investment prospects in advance of its joint venture with Ocado (OCDO).

Investment company news brought to you by Citywire Financial Publishers Limited.