November 2022

Light on the horizon

A week is definitely a long time in politics. We have seen great upheaval since the end of September, culminating in the resignation of Liz Truss on October 20th and Rishi Sunak succeeding her on October 25th. Gilt yields have dropped sharply since then and Sterling has stabilised, making modest gains on the US Dollar recently that has helped more domestically focused UK companies. We held back our Commentary this month to see how the Consumer Price Index (CPI) would be likely to reflect current inflation trends in the US – more on this later. Concerns remain regarding wage demands in the UK at a time of tight labour market conditions combined with the contraction of 0.2% in the UK economy, signaling the start of a recession. On an international basis, Wall Street would probably have preferred a stronger Republican showing in the US mid-term elections.

There are indications that some elements of inflation are reaching their peak, and this is reflected in bond yields, particularly in the US, where money market indicators are pointing towards a CPI rate of around 3% in one year’s time. Unfortunately, the UK figure is still likely to be nearer double figures with much hinging on wage settlements (if they can be achieved).

With confirmation that the US CPI figures were better than expected, we may see a change of leadership in markets. If this is indeed the beginning of a major change of trend in the US, then there is scope for earnings there to be more highly valued. We are keen to maintain full weightings in this area even if markets ebb and flow from here. Lower interest rates should be good for bond investments as well, although we will have to be careful of sectors that have enjoyed favourable pricing, such as Energy, while others struggled.

The UK has not been particularly well served by recent Home Secretaries with perhaps an understandable focus on uncontrolled Channel arrivals. Lord Wolfson, the Next chairman, is focused on the tight labour market resulting in staff shortages, both in retail and elsewhere, damaging economic performance and creating additional inflationary pressure. A more targeted approach to taking in skilled people from abroad, who can contribute immediately to both private and public sectors would be very welcome. We await the announcement of the new fiscal policy agenda, which is expected to include spending cuts and tax rises.

We tend to be cautious about macro-economic events, but Ukraine is an area we still follow closely. We have seen the retreat of Russia from Kherson but Mr Putin’s track record to date does not suggest a quiet retreat. This, and the possibility of another flicker in the inflation number, requires a degree of caution. However, markets have reacted well; inflation is predicted to be much lower next year in the US, and the outcome of the US midterm elections may prove less disruptive than anticipated.

Important Information

Opinions constitute our judgement as of this date and are subject to change without warning Neither CS Managers Ltd, CS Investment Managers nor any connected company accepts responsibility for any direct or indirect or consequential loss suffered by you or any other person as a result of your acting, or deciding not to act, in reliance upon any information contained in this document. CS Investment Managers is a trading name of CS Managers Ltd, 43 Charlotte Square, Edinburgh EH2 4HQ. CS Managers Ltd is authorised and regulated by the Financial Conduct Authority.

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October 2022

A costly exercise in self harm

Central bank intervention is now rife in markets, with the Bank of Japan propping up its currency and, more recently, the Bank of England intervening in the Gilt market. Such developments are symptomatic of ongoing market stresses, resulting in weak equity and bond markets this year.

From a currency translation viewpoint, US Dollar strength continues to benefit UK investors with allocations in US and Asian equities. A divide in performance between the two sides of the Atlantic (i.e. US vs. Europe) has been evident in equity and currency markets of late and looks set to continue as a hard winter of gas concerns awaits Europe.

Closer to home, we have seen a baptism of fire for Liz Truss and Kwasi Kwarteng, (the new Chancellor of the Exchequer) – mostly self-inflicted on their part. While some tax cuts were expected by the new Conservative government, the extent of them spooked markets, with Sterling having traded as low as $1.035 against the Dollar. This is in stark contrast to a rate of $1.21 at the end of June and demonstrates a vote of no confidence in the UK by overseas investors.

We were surprised to hear during the earliest days of the new government, that Kwasi Kwarteng sacked the Permanent Secretary to the Treasury. Kwarteng then effectively ignored the Office for Budget Responsibility to avoid scrutiny as to how the extra borrowing required to offset the huge tax cuts and funding energy subsidies proposed by his Budget, would be secured.

This dash for growth in highly unpromising market conditions has created a crisis of political and economic confidence. With Government finances already stretched in capping soaring energy bills (which, politically, could not be ignored), this significant further borrowing tipped markets into panic mode.

Truss and Kwarteng insist their strategy justification will be clarified in November, when the next formal budget is scheduled. However, the International Monetary Fund (which is ultimately responsible for helping to bail out failing nations through emergency lending) is pushing for them to act sooner. While we have had a partial easing with the Chancellor reversing the 45% tax rate cut, in aggregate this only contributes £2bn-3bn of the package. So, while a welcome reversal, this will be unlikely to alleviate investor concerns around funding of the growth package.

Meanwhile, last week the Bank of England had to intervene in the government bond market, as loss of confidence in Kwarteng and Truss had seen yields on Gilts jump significantly (the UK 10-year yield topping 4.5%). A formal bond buying programme has commenced, the antithesis of what was originally planned to help to reduce the impact of ongoing pressure on the Gilt market. This has wider ramifications in terms of mortgage affordability and stability in the UK financial system, so it looks likely further measures will have to be taken to reduce the impact of this current uncertainty.

Markets have not taken the matter in their stride and the last few days of September were generally punishing for even conservative investors, who have seen price declines in defensive areas of the market, including income orientated funds. This is because the relative attraction of the income yields on these investments is no longer at such a premium to “risk free” Gilts.

We continue to monitor the wider investment universe closely and have positioned portfolios with holdings which do offset some of the current uncertainty in UK markets. While the Bank of England bond purchasing programme, and reversal of the 45% tax cut, has helped steady the 10-year yield around 4.0% and the Sterling rate at $1.12, our positioning remains defensive. That said, we have been encouraged to note the performance of other overseas assets and absolute return hedge funds proving their worth recently. We are still focussed on the initial early signs of a reduction in the rate of US and UK inflation and have raised substantial cash balances to take advantage of this change in trend.

Important Information

Opinions constitute our judgement as of this date and are subject to change without warning Neither CS Managers Ltd, CS Investment Managers nor any connected company accepts responsibility for any direct or indirect or consequential loss suffered by you or any other person as a result of your acting, or deciding not to act, in reliance upon any information contained in this document. CS Investment Managers is a trading name of CS Managers Ltd, 43 Charlotte Square, Edinburgh EH2 4HQ. CS Managers Ltd is authorised and regulated by the Financial Conduct Authority.

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September 2022

New PM, same inflation problem

With the UK at long last announcing its new prime minister, the outlook for Ms. Truss could hardly be bleaker. Not only have fuel prices risen to such an extreme that 12 million households (42% of all households) will enter a state of fuel poverty, this has coincided with increased union action over stagnant public sector wage growth – at a time when economic activity is in decline. The task of balancing the government’s books with the needs of society are difficult at the best of times, but this act is all the more delicate at present.

In anticipation of an increase in unfunded spending under a difficult economic environment, currency markets have already started to discount Sterling against other major currencies. A growing chorus of the potential for Sterling-Dollar parity and rampant inflation is understandable but perhaps still in the extreme in our view. In any event, the uncertainty we are witnessing surrounding the UK economy is likely to continue. However, with a Prime Minster finally to be held to account, at least some form of reactionary policy adjustment to dampen the impact of spiralling energy prices on consumer pockets should help. As is normal with an incoming PM, we do not expect all policy pledges adhered to. The promise of dramatic tax cuts will have to be curtailed to balance increased government spending or subsidies (particularly for those in the greatest need of this) to tide  the UK population over a difficult period ahead.

The wider market fear is that all this will lead to a depreciation in UK government bond valuations, which will push up discount rates and further hinder risk asset performance for UK based investments over the coming period. Meanwhile, consumer pockets (a key driver of the economy) are increasingly being pinched by inflation and this does not bode well for spending and corporate performance. We are positioned defensively with this in mind to help dampen the blow of the negative outlook. Our hope is that policy makers will find the right balance between fiscal prudence and societal support over the coming period – no easy task.

 Looking further afield, the commitment by global central bankers to bring inflation under control, despite the inherent risks to the growth outlook, shook both equity and bond markets recently. We understand their concerns but, at the same time, recognise the issues are supply-side rather than demand-side driven in nature. Hiking borrowing rates is not going to help funding for the development of further shale oil fields in the US, for example, which could go some way to helping resolve the world’s dependence on Russian energy. We do wonder whether the US Federal Reserve is simply pushing the global economy towards a recession to some extent and further exacerbating current inflationary issues. However, the economic data released recently has generally been a bit better than expected, as shown by economic surprise indices, while global inflation pressures started to ease on the back of lower commodity prices. Whether this persists, however, is another matter.

All in all, the level of uncertainty about the outlook for the global economy remains elevated. This uncertainty is especially heightened in Europe. After six months of war in Ukraine there is no sign of a ceasefire, and a recession seems increasingly likely this winter as the region’s energy crisis continues to intensify. We continue to hold allocations to the energy sector as a result of this and believe that the current valuations, while having recently risen, are still depressed relative to the underlying cashflow and profits being generated. Sterling looks set to continue to struggle and, therefore, global diversification remains prudent. Finally, inflation protected cashflows from infrastructure and other assets remain a key feature in our positioning to navigate the period ahead.

It will most likely prove to be a tough winter for markets, but we continue to look to shelter investor capital from current market events as best we can. This is with a view to adjusting positioning in due course, as further valuation compression occurs over the coming period and the relative attractiveness of more economically sensitive sectors catches our interest again. The timing of this will be critical to avoid further downside risk but, when inflation begins to peak and commodity prices start to fall once again, we believe conditions will begin to form again for further broad market gains in the years ahead.

Important Information

Opinions constitute our judgement as of this date and are subject to change without warning Neither CS Managers Ltd, CS Investment Managers nor any connected company accepts responsibility for any direct or indirect or consequential loss suffered by you or any other person as a result of your acting, or deciding not to act, in reliance upon any information contained in this document. CS Investment Managers is a trading name of CS Managers Ltd, 43 Charlotte Square, Edinburgh EH2 4HQ. CS Managers Ltd is authorised and regulated by the Financial Conduct Authority.

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August 2022

Inflation: critical coming months

Following a month of falling bond yields and a modest stock market recovery on the hope of a fall in interest rate rise expectations, markets are once again pausing for thought as we enter August.

With Bank of England raising interest rates by 0.5% to 1.75%, its biggest rate increase since 1995, markets are poised for a further chill in financial conditions. A deviation from the current trend of rising interest rates feels unlikely at this point, despite optimism in recent weeks. We do however acknowledge that a recession will give central bankers a reason to consider just how much demand destruction, through the tightening of financial conditions, will benefit the UK economy in the current situation. This should eventually push them into lowering rates again, which would be positive for risk assets.

The case for monetary policy tightening is driven by the risk that inflation, if left unchecked, could lead to a dangerous wage and price spiral that we have not seen since the 1970s. However, the inflationary pressures do not stem from internal demand excess, as has been the case over the last four decades, but from external factors over which monetary policy setters have no control. Rate hikes will not solve the increasingly urgent food supply challenges or remedy the shortage of natural gas.

The war in Ukraine, which has led to a significant reduction in gas supplies to Europe from Russia, coupled with under-investment in US shale supply in recent years, leads us to believe that the current demand/supply imbalance in gas is not likely to be resolved any time soon. In the UK, the current gas price cap is forecasted to rise by a further 70% in October. This impacts both UK business and consumers and will likely lead to a significant contraction in consumer confidence and spending. Businesses required to use energy for various purposes from industrial production to heating pubs and restaurants, will see a significant rise in costs and resultant profit margin deterioration. It feels somewhat unlikely that the current low level of unemployment will persist, with the UK forecasting further challenges over the coming winter. All in all, none of this is good for the economy or financial markets.

There is also the matter of a struggling global supply chain, exacerbated by the pressure of China’s zero-Covid tolerance policy and the war in Ukraine. Key shipping ports are no longer as constrained as they were, but the situation is not fully resolved in either geography and is still in a state of flux and impacting the rest of the globe.

With this in mind, our client portfolios are defensively positioned at present. We believe that this is the correct conservative approach in light of the deteriorating economic and monetary environment. The green shoots we continue to look out for include a change in tone from central bankers, a deterioration in inflation forecasts, energy price pressures to recede and, ultimately, conditions which would support a sustainable recovery in consumer confidence.  None of these have occurred as of yet, but we are confident that they will, and we will be ready to react accordingly and deploy the current higher than average cash positions held across portfolios. The catalyst will be the first sign of reduction in the rate of increase in inflation rather than the actual peak.

Important Information

Opinions constitute our judgement as of this date and are subject to change without warning Neither CS Managers Ltd, CS Investment Managers nor any connected company accepts responsibility for any direct or indirect or consequential loss suffered by you or any other person as a result of your acting, or deciding not to act, in reliance upon any information contained in this document. CS Investment Managers is a trading name of CS Managers Ltd, 43 Charlotte Square, Edinburgh EH2 4HQ. CS Managers Ltd is authorised and regulated by the Financial Conduct Authority.

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July 2022

Investing in times of rising inflation

We are all adjusting to weak market conditions and, with the S&P 500 dropping through the 20% downside level in 2022, there are more calls that this is now a serious bear market. Our problem is that the rescue elements of past falls are absent at present. Instead of easing monetary conditions the US Federal Reserve, has embarked on a policy of Quantitative Tightening just when real interest rates are negative and the Fed is promising sharp rises to correct this.

The fear and uncertainty surrounding the current market environment has been well demonstrated year to date by a persistently elevated level in the “fear index” i.e. the VIX. This is a measure of forward-looking volatility expectations and has been higher than recent historic averages, ever since the Russian invasion of Ukraine.

Macroeconomic pressures continue to trouble investors and include (but are not limited to) the Ukraine induced shortage of grain and sanctions on Russia, which have caused a sharp tightening of energy prices at a time when supply was already falling short relative to demand.  ESG/sustainable investment influences on energy projects has resulted in falling capital expenditure for new projects and sums now required to bring further supply on stream are substantial. This is the case  even  in the US, where the relative costs for shale are a fraction of that to extract North Sea oil.

Previous optimism by the US Fed calling inflation pressures “transitory” are now seen as unrealistic and this places huge pressure on the authorities to sharply increase interest rates. The amount that the market will pay for equities is heavily influenced by prime bond yields,. If  interest rates should rise to 5%, growth stocks will be particularly affected as a PE ratio of c.20x will be about as much as the market would normally pay. This implies that further weakness in equities is likely as this is a possible ceiling for stocks of the highest quality.

The economic factors mentioned above are likely, in a period of high employment, to result in demands for higher wages. This is a critical factor, as this stage of the cycle tends to result in a rising cycle of higher payments, which only slows when higher interest rates result in rising unemployment. The alarming thought is that there seems to be little scope in any significant area to ease these pressures and protect current equity and bond valuations.

In anticipation of these events developing, we have reduced allocations to equities across portfolios and increased cash positions in order to provide some “dry powder” to deploy into any pockets of value which we encounter over the coming period. In addition, the equity allocations which remain are largely invested in value stocks which should be better placed to reduce any potential further market drawdowns over the coming period. Meanwhile, we have also moved to a significant underweight position in fixed income across portfolios in favour of alternative assets such as infrastructure and property. These asset classes stand a better chance of preserving the real value of your capital in an inflationary and rising interest rate environment (such as the one we are in now), relative to fixed income and this has helped to reduce volatility so far in 2022.

Looking ahead, we continue to look to get on the front foot and are continuously searching for areas of the market which hold promise to swim against the current tide. While the growing consensus view is for inflation to peak later this year and a potential market recovery to ensue, we remain in tricky conditions and continue to manage portfolios carefully. However, history does show that markets anticipate future growth . Financial projections by the Monetary Policy Committee anticipate inflation dropping to low a low single figure in 2024 and we need to be alert to this, as it would be favourable to equity markets.

We would strongly encourage anyone who is concerned about their portfolios, or who has had a change in risk appetite to contact us, in order to discuss the current environment and how we are looking to help protect your capital at present and grow your position over the long term.

STOP PRESS: Boris Johnson resignation

Markets like certainty; initial reaction should be good for Sterling.

The US Fed seems determined to make up for lost time with interest rate rises; these factors should lead to helping contain inflation. We feel this is the key indicator to watch at present and should help bring forward a decent based period for equity markets.

Important Information

Opinions constitute our judgement as of this date and are subject to change without warning Neither CS Managers Ltd, CS Investment Managers nor any connected company accepts responsibility for any direct or indirect or consequential loss suffered by you or any other person as a result of your acting, or deciding not to act, in reliance upon any information contained in this document. CS Investment Managers is a trading name of CS Managers Ltd, 43 Charlotte Square, Edinburgh EH2 4HQ. CS Managers Ltd is authorised and regulated by the Financial Conduct Authority.

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June 2022

The Storm before the Calm

Events seem to be conspiring to unsettle investor confidence, which leads us to increase emphasis on protecting value as much as seeking to increase it. Inflation is rising and, unless curbed soon, will lead to sharp increases in interest rates. Both factors look set to prompt increased wage demands at a time of full employment. This combination is already proving toxic in technology markets with prices falling and funds hard to secure. Russia is suddenly advancing in Ukraine and George Soros warns in the Daily Telegraph that Ukraine could be the start of a Third World War. The Financial Times adds to the cheer by indicating that technology stocks in the US are now in a traditional bear market.

We are now basing strategy on a tough couple of years where an underlying priority will be securing solid income to tide investors over any period of market volatility. Long term interest rates seem likely to increase, and the usual effect of authorities increasing short term interest rates in response is to tip economies into recession, to bring inflation under control. This places a premium on stocks that are liquid, have strong cashflow, which in turn permits rising dividends. In bond and credit markets the safest places are in short duration or early maturity dates; cash becomes more attractive as well.

There is talk of a possible pause in the US of increasing interest rates as sharply as recently indicated, in the early autumn. However, continuing pressure on energy and cereal crops suggest this hope might be short lived, and we face even harsher interest rate increases slightly later. We hope to use this period to storm proof your portfolio as much as possible and leave it in a strong position when these crises abate.

The UK is usually the poor relation of global markets with the FTSE 100 not much higher than in 2000 when markets peaked. Large capitalisation stocks have often been overshadowed by faster growing new and smaller companies with investors willing to wait until they developed and matured. Now companies suffer sharp valuation declines and sometimes worse as additional funding comes at much lower levels, or not at all.

Much is changing on a global basis, and Soros now criticises the previously well-regarded Angela Merkel for leaving Germany hostage to Russian gas, and to China for their major export market. In the short term we will have to be patient on the ESG (Environmental, Social & Governance) front as wind power cannot propel cargo ships and solar panels cannot put planes in the sky. The understandable pressure to protect the planet has come at significant cost to security. As income generating companies in, say, the energy sector have been discarded (so that it only represented 2% of the main index at the low point) opportunities have been created for investment managers prepared to use the full palette of investment choice.

Important Information

Opinions constitute our judgement as of this date and are subject to change without warning Neither CS Managers Ltd, CS Investment Managers nor any connected company accepts responsibility for any direct or indirect or consequential loss suffered by you or any other person as a result of your acting, or deciding not to act, in reliance upon any information contained in this document. CS Investment Managers is a trading name of CS Managers Ltd, 43 Charlotte Square, Edinburgh EH2 4HQ. CS Managers Ltd is authorised and regulated by the Financial Conduct Authority.

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May 2022

Coincident Factors

The Russian invasion of Ukraine has been the exception to the generally modest impact that geopolitical events have had on global markets. As such, it has had a catalytic effect on underlying trends that had previously seemed containable. The traditional remedy since the financial meltdown in 2008/9 in the US has been to decrease interest rates and increase money supply. Both strategies have been taken, broadly, to extremes. At the same time, Covid has disrupted supply chains, compounded in the UK by the difficulties of Brexit.

The impact on Ukraine, in addition to human misery for so many, has been to severely restrict the supply of grain from one of the largest exporters. Similar pressure has been felt in the energy market, where the threat of restricted gas supply has sent prices soaring.

In aggregate, tighter monetary conditions, rising inflation and tougher trading conditions are likely to result in narrower margins for the majority of companies.  Our task is to find the minority that thrive in these conditions. We will look to include companies that benefit from rising commodity prices, rising interest rates and rising inflation. We have seen in past cycles the emphasis that investors put on immediate returns in these conditions, including some element of yield, strong cashflow with little balance sheet debt and valuations that do not require multiple years of growth to justify current lofty ratings.

As an example of changing trends, it is interesting to note that the previously buoyant rating of NASDAQ has dropped sharply since November, and the apparently more sedate Berkshire Hathaway holding run by Warren Buffet has caught up with it. This seems a clear indicator that in a rising interest rate environment, investors will pay more for immediate certainty and income, and less for long term growth prospects that require a higher valuation discount, as the more distant growth will be curtailed in real terms by inflation.

As we move from an era of Quantitative Easing to Quantitative Tightening, resulting in higher interest rates, this dictates that we need to re-deploy funds to protect your portfolio by seeking out beneficiaries of such changes. The factor that is likely to create some market confusion in the interim is that the year-on-year inflation rate will hopefully slow as we grow accustomed to higher food and energy costs.  However, real incomes will have fallen and corrective action has not yet been taken to correct this. The damage that can be caused by ignoring inflation can be seen in Turkey where the central bank was overruled on interest rates, and less than a year later inflation surged to 30%. US and UK authorities are talking about tough action, but already they may be behind events which require prudent action now.

Important Information

Opinions constitute our judgement as of this date and are subject to change without warning Neither CS Managers Ltd, CS Investment Managers nor any connected company accepts responsibility for any direct or indirect or consequential loss suffered by you or any other person as a result of your acting, or deciding not to act, in reliance upon any information contained in this document. CS Investment Managers is a trading name of CS Managers Ltd, 43 Charlotte Square, Edinburgh EH2 4HQ. CS Managers Ltd is authorised and regulated by the Financial Conduct Authority.

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April 2022

The Winds of Change…

Since our last publication of View from the Square, the wider market outlook has changed dramatically. While a humanitarian tragedy continues to unfold in Ukraine, markets have proved to be somewhat resilient in the face of mounting macro-economic concerns. To put it candidly – traders have been insensitive to both the humanitarian and macro-economic issues unfolding. We disagree with this viewpoint on a one to two year view, despite the “music still playing” and markets recovering in recent weeks from their earlier selloff. For now, we continue to benefit from these trends, but we are positioned more conservatively than previously given the longer-term implications at play.

Just yesterday, the US government bond yield curve started to invert – a signal whereby the yields on shorter dated bonds begin to exceed those of longer dated maturities (in this case, the US 2-year government bond yield has risen above that of the 10-year yield). This has historically proved to be a fairly reliable indicator of an impending recessionary environment. While several of our peers and a chorus of economists are suggesting that “this time is different” (a phrase we generally approach with extreme caution) as the inversion is being driven largely by shorter term expectations rather than a much longer-term decline in growth and/or inflation assumptions, the outlook is far from as healthy as it once was.

Consumers are being hit by a number of key inflation factors, ranging from energy prices to commonly purchased goods in their supermarket baskets. The fundamental driver of this is not just a rise in energy prices, but also weakened global supply chains. The latter is a combination of the Covid pandemic and the ongoing deglobalisation trend we are witnessing from the Russian war on Ukraine, in addition to geopolitics surrounding technology nationalism and the redrawing of supply chains. The recent announcement of Intel’s $88bn European expansion is just one such example of this, as large companies begin to “wise up” to these trends and look to protect their access to key markets – we suspect that others will be less prepared and caught out by this trend over the coming period, which would likely continue to erode consumer confidence.

Important Information

Opinions constitute our judgement as of this date and are subject to change without warning Neither CS Managers Ltd, CS Investment Managers nor any connected company accepts responsibility for any direct or indirect or consequential loss suffered by you or any other person as a result of your acting, or deciding not to act, in reliance upon any information contained in this document. CS Investment Managers is a trading name of CS Managers Ltd, 43 Charlotte Square, Edinburgh EH2 4HQ. CS Managers Ltd is authorised and regulated by the Financial Conduct Authority.

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March 2022

Keep Calm and Carry On

The events of recent weeks in Eastern Europe have dominated TV, radio, newspapers and online news. These events have also seen market sentiment deteriorate as investors increasingly price in the prospect of damage to the global trade environment. Meanwhile, the prospect of a greater inflationary burden than was anticipated at the beginning of the year has also led to a repricing of risk, as the supply of key energy sources has come into question, pushing the price of oil to a 7 year high.

There is no doubt, that certainly in the short-term at least, the global growth outlook has deteriorated because of the war between Russia and Ukraine. Western powers have responded swiftly with sanctions which will hurt the Russian economy. Even the historically neutral geographies such as Switzerland and Monaco have joined in this, which is unprecedented relative to previous wars.

As with many matters in life, the most important element is how you respond to challenges, uncertainties and sources of volatility. To this end, it has been noteworthy over recent days that the economic restrictions on Russia have been applied more quickly and more thoroughly than in other historic geopolitical crises. Unfortunately, it has not yet stopped the invasion of Ukraine, but it has significantly heightened the rationale for a return to peace.

Markets are priced for a medium-term disruption in certain sectors, but not priced for a broader disaster. You can see this in “safe haven” assets (such as government bonds, the Japanese Yen etc), where the flight to safety has, so far, been measured. The big issue going forward, as far as we see it, is the potential for a further rise in inflation and, in particular, key commodity prices. It is already looking as if central banks have moved too slowly to combat this issue.

The invasion of Ukraine may now make rises in interest rates less likely in the short term but also more necessary in the medium term as inflationary pressures grow.  Unfortunately, events also make it likely that the post-Covid economic recovery we have been looking forward to will be weaker, especially in Europe. Raising interest rates to control inflation when economies lack resilience can lead to stagflation (high level of inflation, accompanied by a low degree of economic growth) and unhappy times for equity investors.

Important Information

Opinions constitute our judgement as of this date and are subject to change without warning Neither CS Managers Ltd, CS Investment Managers nor any connected company accepts responsibility for any direct or indirect or consequential loss suffered by you or any other person as a result of your acting, or deciding not to act, in reliance upon any information contained in this document. CS Investment Managers is a trading name of CS Managers Ltd, 43 Charlotte Square, Edinburgh EH2 4HQ. CS Managers Ltd is authorised and regulated by the Financial Conduct Authority.

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February 2022

Spiking the Punch Bowl

January 2022 has not started where 2021 left off. The all-time highs across various equity markets last year have receded on the back of concerns surrounding inflation, which has caused central bankers across the globe to consider raising interest rates and reducing asset purchases. The US Federal Reserve (the Fed) has indicated that several rate hikes over the course of the year are planned, in addition to “rolling off” the Fed balance sheet, by no longer providing the same degree of ongoing purchases of low-risk assets (such as government bonds) from the US banking system. A reduction in banking system liquidity, in conjunction with a rising interest rate outlook, has not been taken well by investors this month, with equity indices falling across the board.

Asset prices across various investment markets, including key equity and bond markets, are being impacted by a rising cost of capital as a result of the US base rate rising. This is because asset valuations are calculated with consideration of the level of interest rates, with additional discounting in price considered for any rise in this key measure, as well as inflation and/or perceived asset-specific risk.

The base case now is for 5 rate rises this year of 25 basis points, which would raise the US target base rate to 1.25-1.5%. At the turn of the year, the market was braced for one rate hike by the May meeting. Now it has fully priced in two, which many believe will come in the form of a blunderbuss 50 basis points hike at the next Federal Open Market Committee meeting in March. Within 12 months five hikes are now priced as a certainty. That’s a radical shift in expectations and investors now appear to fear that the Fed may be spiking the proverbial market’s punch bowl.

The effect the Fed is hoping for is a reduction in the rate of inflation, which is now running at an uncomfortably high figure of 7%. While an element of this is no doubt due to the one-off substantial rise in several input costs because of a recovery in post-pandemic economic activity, there is a fear that some of this may prove to be “sticky” or even prove to be self-reinforcing. We expect the headline figure of 7% to fall over the coming period, but we do however expect it to remain relatively higher than it has been in recent years.

This issue is not isolated to the US, with the Bank of England also poised to raise interest rates later this week from 0.25% to 0.5%, with the market anticipating gradual rises to eventually reach 1.2% by year end. We expect that some of this hawkish interest rate outlook is already priced into markets, however we do expect some volatility over the year ahead as expectations wax and wane upon consideration of unpredictable inflation prints over the course of the coming year.

Important Information

Opinions constitute our judgement as of this date and are subject to change without warning Neither CS Managers Ltd, CS Investment Managers nor any connected company accepts responsibility for any direct or indirect or consequential loss suffered by you or any other person as a result of your acting, or deciding not to act, in reliance upon any information contained in this document. CS Investment Managers is a trading name of CS Managers Ltd, 43 Charlotte Square, Edinburgh EH2 4HQ. CS Managers Ltd is authorised and regulated by the Financial Conduct Authority.

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