Global Weekly: Adding spice to a portfolio

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This week trade tensions between the US and China arose again, with the US saying that in two weeks it will begin imposing 25% duties on an additional USD 16 billion of Chinese imports. China, in turn, says that it will retaliate. Investors also remain concerned regarding Brexit negotiations and budget talks in Italy.

In the equity market, we continue to see some positive momentum, especially in the US. The end of the US earnings season is approaching, with almost 90% of the companies in the S&P 500 Index having published their results. More than 80% of these companies had a positive earnings surprise, meaning that earnings were better than analysts had expected.

Within the materials sector there is a small subsegment within specialty chemicals, which comprises only a very few producers of flavours & fragrances. This subsegment consists of three big players and a number of non-listed, niche companies that are likely takeover targets. The three large companies, International Flavors & Fragrances (IFF), Givaudan and Symrise, are the only players that companies such as Unilever, L’Oréal and Procter & Gamble want to deal with when it comes to the crucial flavour & fragrance ingredients for their products.

Since these ingredients are only a very small (less than 3%) portion of production costs, they are close to being immune to manufacturer cost-saving programs. This gives the companies pricing power and makes them highly profitable, with operating margins between 15 to 20%. They therefore always trade at high multiples. Two of them have recently released their quarterly results. The results were again good, despite higher input costs, which are covered by price increases. For a long-term buy-and-hold strategy, these may be good companies to have in your portfolio.

Italy’s budget talks heating up

In the first weeks of August, Bund and US Treasury yields moved sideways and did not push through the levels of  0.5% and 3% respectively. They did, however, briefly touch these yields. Corporate spreads in developed markets also moved sideways, as incoming macroeconomic data and investor positioning provided little incentive for markets to move.

Italian government bonds were an exception, as the political debate over next year's budget is starting to heat up. On the one hand, Italian Prime Minister Giuseppe Conte and Finance Minister Giovanni Tria are aiming for a deficit of 1.5%, which  is well within the EU’s limits. But, on the other hand, League leader Matteo Salvini and Luigi Di Maio of the Five Stars party are pushing their desired tax cuts and citizen's income proposals, which challenge the EU budget rules. Wider spreads for Italy were a clear signal from financial markets where investors would like the discussion to end up.

Emerging market spreads also widened in August, after tightening in July in tandem with most spreads. Trade tensions continue to dominate the headlines, while the economic situation and the outlook in emerging markets look more uncertain than in developed markets, where tentative signs of more synchronised growth are rising. Developments in Turkey, where interest rates reached 20% after the diplomatic confrontation with the US, illustrated the vulnerability of some individual countries in emerging markets and added to the relatively cheaper valuation of  emerging-markets assets in general. The longer term outlook for emerging markets may be favourable, but in the shorter term, the first couple of months still look challenging.