From chaos to opportunity: Why PM Capital is holding course on European banks and commodities

Ben Warnes: Hello and welcome to this PM Capital update with our CIO, Paul Moore.

Paul, what a week it’s been. I thought it would be a great opportunity for us to sit down to understand your current thinking, especially with everything happening in markets.

To start off, what is Trump trying to achieve, and how is he progressing towards that?

Paul Moore: There’s certainly never a dull moment in markets. But I think you’ve got to look past the noise. There are three big issues that have been staring the US in the face for quite some time: the ever-increasing fiscal deficits and thus debt, the perpetual trade deficits with the rest of the world, and the increased security threat posed by China in the pacific. So really that’s the end game.

Now for the US, he wants lower taxes to drive the economy, he wants lower interest rates, lower regulation, lower US dollar. On the surface, they are all good things—but the hard part is how do you do that in a background of record fiscal and trade deficits so you could argue there is a low margin for error, great aspirations but low margin of error.

If you look at what’s actually happened, it’s all very logical in my mind.

First of all, we need the Ukraine war to stop. That allows the US to cut back on defence spending.

Second, the Europeans need to take more responsibility and fund their own defence. We’ve been saying for years: why should Europe—with a trade surplus—having their defence spending funded by the US with a trade deficit? It doesn’t make any sense. That allows the US to reduce its spending and deal with its waste. That then opens the door to tax cuts. But tax cuts without spending restraint are inflationary, as is a lower dollar and lower interest rates. Effectively, he is trying to deal with that first and also the Middle East.

You may have noticed recently that Iran is now at the table talking for the first time in a long time because they need to deal with the Middle Eastern so that they can solely focus on China. That’s the end game. What we are seeing today is a function of that.

Ben: Trump has been very clear that tariffs are part of his plan, and they’ve come out much higher than expected. Why has the equity market reacted the way it has?

Paul: If you go back to when Trump was elected, lower rates, lower taxes, lower dollar, less regulation – they are all good things. So, you saw this bump in the market, but it then ran into what I call a barbell valuation: where parts of the market are very expensive, while others are quite cheap.

These are great aspirations, but they’re very difficult to achieve when you’re dealing with high debt levels and record trade deficits. Markets quickly worked out that there would be bumps along the way. In the March quarter, we saw flows went from expensive to what I’d call more reasonably priced. So, I’d argue the March quarter everything was very, very rational.

In terms of the tariffs, I think the end game is 10% across the board that pays for the tax cuts. It’s like a GST—Europe has GST, Australia has GST. The only difference here is that a tariff taxes the seller of the product, rather than the consumer.

It is all quite sensible and what markets were expecting, maybe certain situations a bit higher but when the tariffs came out, not only were they extreme like Vietnam facing tariffs up to 50 to 60%. The simplistic approach of saying here is your trade surplus that is the tariff applied. The world’s not that simple and is going to create mayhem. It puts world trade at risk and the reaction from the market was everything down!

One of the issues with tariffs and what is happening with defence spending etc, we have been saying in our presentations recently: whether these changes are good or bad ultimately depends entirely on how people react. For instance, when Trump said the US might pull out of Ukraine- noting if Germany doesn’t want to defend themselves why should we. Not long after, the German government committed $500 billion to defence spending, then a $500 billion to infrastructure. Trump created a crisis to force change. The reaction to that was very good—especially for European banks, which benefit from higher interest rates, this was the perfect environment for them.

But if people react the wrong way it could also be very bad. So, what happened when these extreme tariffs came out, the market said, “If that what he really wants, we’re got trouble.” China didn’t do a Europe they retaliated, and that’s when the markets really got nervous because if they want to fight this out everyone is a loser. It wouldn’t just be a recession—it could be a depression.

In two days, we essentially saw the equivalent of the 1987 crash. Back then, it took one day; this time, it was two days. You could even argue it wasn’t irrational because if we go that extreme on tariffs, world trade is in big trouble. Now they have dialed it back very, very quickly.

The market still believes that they are going to some form of resolution, that somehow, they can sort this out. You could argue we have already seen the bottom but you still have to be a bit careful - if China digs its heels in, they have the most to lose—, they have the big trade surplus and their economy has to transition—so China who is fundamentally actually quite weak, needs to get a resolution to this. They recognise this as they have made consumption the number one priority. So even though they are fighting it, they are very clear on the issues that they have to face. How it ends up will depend on do we get back to the end game where there is a 10% tariff, we deal with surpluses and deficits, Europe deals with their defence spending and then it could be quite good.

Ben: Let’s turn to the Global Companies Fund. What does all this mean for the portfolio’s key themes—European banks and commodities?

Paul: Medium to longer term, our view hasn’t changed. Again, part of it depends to how the world reacts. Worst-case scenario, it’s not good for anything, so don’t waste time talking about its impacts - it is bad for everything.

If you look at how Europe seems to be responding and taking responsibility for its defence and fiscal issues, that is very good for European banks. But, if there’s a recession, lower interest rates that’s obviously not so good. I think this is going to be the final test for European banks. What you have seen today is a move based on their earnings, people still don’t want to rerate despite higher capital, higher dividends so this will be a great test. If the banks can hold up through this, that’s when we will see the evolution of the thesis and you’ll see re-rating of European banks.

Commodities are a bit different. A recession isn’t good for them, but on the other hand gold’s been strong, and copper has held in pretty well the stocks are discounting because of recession but we haven’t changed our view that medium to longer term, we think the real action in commodities will be around 2027–2028, electrification ramps up and Trump wants a lower dollar – good for commodities . So again—no change to our thought process.

Ben: You mentioned the US dollar. Given the Global Companies Fund actively manages currency, what are your thoughts on the Australian dollar both short and longer term?

Paul: With the election of Trump and tariffs, the currency piece has probably been the most the most difficult part of the equation.

Medium to long term, I use the anecdote of orange juice at the New York hotel back in May and it was $28 Australian dollars. That tells you the US dollar is very expensive—combine that with the fact that Trump wants a lower dollar, and if he solves these big issues, it actually means flows will go from the US to the rest of the world which will means a lower US dollar. So, I’m fairly confident medium to longer term, the US dollar will be lower and therefore you want to be hedged out of US dollars.

Short term, it’s very difficult because if the market gravitates to recession, as in the last week, the Aussie dollar goes down when they start focusing on – “maybe it’s not that bad and the end game is lower interest rates” – the currency goes up.

The euro is actually higher than it was at the start of the year. The Aussie is about the same. So we haven’t changed our view—it’s just inherently hard to manage short term. The opportunity cost short term has probably been 4-6% but I go back the $28 orange juice – the US is very expensive.

Ben: In times like now, when ambiguity is so high how do you and the team think about positioning the portfolio? Is there anything specific you are either adding to or trimming at the moment?

Paul: Yes, if you go back pre all this kerfuffle, even late last year, there were some interesting opportunities opening up—even though the market was at high you had quality companies like spirits Pernod down 50% from their highs, Heineken down 50% on a 10PE. So, we started buying into a number of different positions, slowly because the market was at a high. Then as the market rotated, a few other opportunities started to appear. When the market was down 10 or 12% we reduced our futures hedge to increase our invested position—the fund went from 85% to 95/98%, we were selling some puts through that period because again we were a little bit worried about the market risk but with volatility blowing out and some of these stocks coming back to where we thought they were interesting like Disney, you could write puts that would get you in at a pretty attractive price. So as a result, the invested position has gone up to the high 90s.

When China announced their tariffs and it took another leg down, those two days did surprise us a bit and we are now 102 - 103% net invested. That is how we have dealt with it short term but as mentioned there are a number of opportunities that have now opened up which we are considering in terms of rotating existing stocks into that, we don’t want to increase our overall exposure because I still believe and having being saying for two years maybe longer when market valuations overall is at a high, you have this excessive valuation from passive investing, in Australia you have the industry concentration with the big industry super funds and so Australia is really extreme in terms of valuations.

We’ve been saying: whatever your risk profile is, take it down a bit. Everyone has different risk profiles but whatever it is take it down a notch. Recent events have been testament to that. This sort of environment, irrespective of how this plays out in the short term, is going to continue so you don’t want to go all in despite stocks having come back. The reality is a lot of them have come back but they are only back to where they were at the start of the year because we’ve had such a great one, three, five year returns prior to recent events.

We’re chipping away, we have taken our exposure up. There’s a saying: when you have got all this turmoil and we go back over 25 years and whether it’s a GFC or COVID, it is crazy what comes out – the only thing you can do to deal with risk when chaos hits, you need to think longer term, focus on valuation, ‘and be patient. And from that perspective, nothing has changed.

Ben: Thank you, Paul, for taking the time to share how we’re thinking about markets right now.

And to our investors—thank you for your continued support. If you have any questions, please visit the PM Capital website or contact a member of the distribution team.