'Stock Take' (Part 3) - The Financials
The Blind Squirrel's 'Monday' Morning Notes. Year 3; Week 25.
Big changes coming to Blind Squirrel Macro at the end of June. If you missed the earlier emails, details can be found in the post linked below.
During June, before Blind Squirrel Macro moves completely behind the paywall, we are going through the process of re-underwriting all of the live Acorn trades and revisiting the 'bull pen' of themes that we have closed out the trade but continue to monitor. This week we tackle the financials from financial exchanges, digital payments and banks (from Japanese behemoths to advisory boutiques) to our old friends at #TeamSaddlebags!
The Widow Maker
Just as the 🐿️ was assembling thoughts for this week’s ‘stock take’ on financials, I took a call from an old friend at the Financial Times in London. She wanted to talk about ‘The Widowmaker’. If there was ever a ‘graveyard’ trade for macro managers that was more painful than betting on higher Japanese government bond yields over the years, it was the idea of taking out shorts against Australia’s ‘Big 4’ lenders.
Those believing that the Bank of Japan’s extreme monetary experiment would end with an explosive blow out in JGB yields were tortured as mercilessly as those convinced that recessions had not indeed been rendered illegal in Australia and that the implosion of the Lucky Country’s highly levered residential property sector would surely blow a ‘bunker-buster-sized’ hole in bank balance sheets ‘Down Under’.
My pal
used to joke that no PM on earth had a better Sharpe ratio than his (Melbourne-based) mother. Australian savers have been happily compounding the ‘fully franked’ (tax free) dividends in their ‘super’ funds for ever.
Once again, the MSCI index compilers have created a monster. Nearly 15 years ago, I stood back in wonder as grown men pushed each other out of the way to scramble to buy the shares in India’s HDFC Bank I was selling to them at around 4 times trailing book value.
Today, as 15 cents of every MSCI-benchmarked dollar touching Australian equities piles into Commonwealth Bank (CBA:ASX), the lender commands a similar eye-watering multiple. Quite a reward when you consider that CBA is only expected to compound its earnings at 4.3% over the next 3 years!
The 🐿️ sometimes whether or not the index compilers might become the maligned ratings agencies of the next crisis? Food for thought. Have a read of Jenn’s piece 👇:
Back to Dumpster Diving in Blighty?
At the end of the emerging markets edition of the ‘Stock Take’ last week the 🐿️ ran out of time to continue with the closed end fund theme I was running and revisit our UK Midcap Investment Trust idea. You were spared all of those Pound Sterling / ‘GB Peso’ jokes!
The 🐿️ finally got over his post-Brexit grumpiness around UK assets in November 2023 ‘Dumpster diving in Blighty’. The acorn was built around a basket of UK small and midcap focused investment trusts, closed end funds containing very cheap equities that were trading at steep discounts to NAV (and getting some trust-busting attention from Boaz Weinstein’s Saba Capital - and he isn’t going anywhere).
We exited the trade - after a decent run - in late October. The honeymoon period for the new Starmer administration’s honeymoon appeared to be coming to an end. An unexciting (from a growth perspective) debut budget saw sentiment leaking from UK risk assets.
It was the right decision. A nasty round trip was avoided in to ‘Liberation Day’. Nevertheless, the rally off the April lows has been a textbook case of bad news, good price. UK midcaps have shrugged off weakening hard (GDP, payrolls) and soft (PMIs) data, twinned with a resurgent vote share for populist forces in May’s local elections (probably irrelevant longer term, but a risk). This has the 🐿️’s whiskers twitching.
One of the reasons that I am considering rejoining the party after missing the first 30% off the lows is that I still believe that one of the key pillars underlying the original UK midcap thesis is still very much in place - namely the ‘cover bid’ that is in place from M&A markets.
The UK’s public small and midcap cap sector closed almost 90 ‘take private’ transactions in 2024, with a staggering c.5% of all UK listed companies receiving public approaches from strategic or private equity buyers.
Regular readers will know that this rodent is wary of ‘Zombie Beta’ and that midcaps are for stock pickers. For this reason, simply buying FTSE 250 futures or EWUS 0.00%↑ (the MSCI UK Small Cap ETF) is less appealing than returning to our original basket of (actively managed) investment trusts, which continue to trade at double digit discounts to NAV.
Once again, I lifted the hood on the ‘Top 10’ holdings from each of the constituent funds within the basket. Broad sector diversification; average returns on invested capital of 16%; and ‘double digit’ average revenue / cashflow / earnings growth over next 3 years.
Ignore the noisy headlines re. UK macro - this is an interesting basket and don’t forget, when one of the underlying holdings get taken over, you effectively get the trust NAV discount back on top of whatever takeover premium is paid!
It really is a single stock picking paradise for those that want to dig in - with 5 professional teams doing the initial screening for you! If you are a Koyfin subscriber, I have put together a worksheet with the names - DM me for a link.
For the more analog among you, here is a summary spreadsheet with a subset of the static data:
I think we need to revisit this basket soon. I was cheered to learn that Jim Mellon is a big fan of the UK investment trust trade too when I was sent a link to this conversation by my friend HR the other day.
The only small problem I have with the trade is currency. Back in late 2023, GBP was still looking relatively cheap. It is now trading pretty close to fair value on a trade-weighted basis. Using a real effective exchange rate logic, a yen hedge is tempting, but GBPJPY is still in a strong uptrend.
Hiding from the ‘tape bombs’ in the Exchanges
The 🐿️’s response to the avalanche of Executive Orders hitting the headlines and triggering portfolio changes in late January was to buy the beneficiaries of increased flow - the financial exchanges.
Since then, the exchanges have comprehensively outperformed most of the securities that trade on them.
They are not cheap stocks, but frankly they never have been. The majority of the basket constituents remain in decent uptrends, only LSEG and Japan Exchange are currently below their 200-day SMAs.
The 🐿️ thinks that the exchanges offer some rare financial characteristics that make those valuation multiples sustainable and well suited to the period of inflation volatility that I see over the horizon.
Capital-light exchanges largely operate quasi-monopolies and are able to raise prices much faster than their (largely fixed) costs; trading flows (and revenue) increase with rapid investment regime shifts; and they enjoy an indirect linkage with real assets (commodities / equities) without exposure to direct price risk. I suspect that we will be sticking with this group for a while.
Battered (so far) by the Boutiques
Partly motivated by a desire to reduce volatility (and increase staying power) in the Exchanges trade, the 🐿️ added a short basket in M&A boutiques in late April.
These stocks were a quintessential ‘Trump Trade’ that rallied aggressively in late 2024 on optimism that a ‘bonfire of regulations’ would usher in a new golden age of merger activity. The 🐿️ was late to the trade and that tardiness has been costly. The basket moved 20% against me rapidly even as policy uncertainty post ‘Liberation Day’ continues to stifle a renaissance in deal making activity.
Hindsight Capital LLC would have bought the Morgan Stanley 6/20/25 $120 call option offered up by the 🐿️ as the paired hedge. Those calls expired on Friday +520%! Sadly, I felt that I already had enough financials exposure on the long side with the exchanges…
Notwithstanding the early pain we are going to stick with the position. These boutiques are going to need to execute their full deal backlogs (plus some) to justify the premium valuations at which they currently trade and their initial momentum in late April / early May now appears to have stalled out.
Back in the Japanese banks trade
I was joking at the beginning of the note about the ‘short JGB’ trade being the original ‘widow-maker’ for Global Macro PMs. Well, that game changed dramatically at the end of 2022.
The 🐿️’s preferred way of playing the ‘normalization’ of the Japanese yield curve over the past 2.5 years has been via its banks, specifically Nomura’s TOPIX Banks ETF (1615.JP) and I updated my thinking on the topic back in February.
Outperformance of the banks versus broader Japanese equities has been significant and I have been impressed how quickly the banks have managed to re-establish positive trend after macro shocks such as Silicon Valley Bank in March 2023 and the Yen carry unwind of last July.
After getting back into the trade in February, ‘Liberation Day’ pretty quickly created another of those macro shocks (and stopped me out). However, based on the shock recovery track record of the sector, the 🐿️ got back in rapidly (as soon as 1615.JP recovered its 200-day SMA). The banks have now fully recovered positive trend in half the time it took to get over last summer’s carry crash. These ‘dip repair’ cycles are getting more rapid.
I have had a couple of questions from readers about the ‘Big 3’ banks’ unhedged exposure to JGBs in a rising yield environment. This is not a huge concern for me. The large banks’ exposure to JGBs is only 3-5% of total assets, with only 20% of that amount estimated to be unhedged.
The ‘Big 3’ (70% of the TOPIX Banks ETF) are not trading as cheaply as they were (relative to international commercial banks). However, I am very comfortable owning them (with a trailing stop) at 1x P/BV (LTM) and 10.4x forward earnings while the chart continues to trend so well.
Time to talk ‘Team Saddlebags’
For several years now, the 🐿️ has been monitoring the storm clouds brewing over ‘Team Saddlebags’, my collective term for the private equity / private credit / commercial real estate complex. Newer readers can follow the thread back to 2022, starting with the ‘Saddlebags Redux’ piece from February.
This theme is linked to the short position in the M&A boutiques (for whom ‘Big Privates’ represents over half of their business), but I am currently positioned for the main theme via short positions in Blackstone BX 0.00%↑ and Invesco’s Global Listed Private Equity ETF PSP 0.00%↑. It was time.
The steady drip of headlines - from private equity portfolio sell-downs by major university endowments; the fundraising slowdown, the proliferation of continuation funds; to the frantic creation of new retail distribution channels (‘interval’ funds, ETFs and 401k eligibility) to re-accelerate LP distributions - is beginning to reach fever pitch.
There is always a quote from 🐿️ hero Cliff Asness:
“I’m going to hedge this and say it very carefully: I think it’s a terrible idea. There are things that end up in retail in a very good way, eventually... This feels a little bit more like we’ve exhausted the institutions. I think I saw a number saying endowments are like 43% — for a number I can’t verify, that’s wildly specific, but that’s the number I remember. So, it has a feel of ‘who else are we going to get to own this stuff’?” AQR’s Cliff Asness on Matt Levine’s Money Stuff podcast.
I finally plucked up the courage to ‘Take on Omar’ (🐿️ code for Black- ‘if you come at the King’-stone) in late February. It was a long wait. We paired a short position in the common stock with some January 2026 $150/$125 put spreads.
So far, the patience has paid off, even if I am expecting some chart support at the $115 to $125 per share level (where BX 0.00%↑ spent most of the first half of 2024).
PSP 0.00%↑, the other element to the short position, is making a much more valiant attempt at defending its 200-day SMA but the chart (not to mention the underlying businesses) but still looks vulnerable to this rodent.
That’s all for Part 3 of the annual stock take. I had hoped to include my updated thoughts on fintech and digital payments following last week’s GENIUS Act news relating to US stablecoin legislation. I will incorporate those thoughts into the tomorrow’s note.
Next week’s final edition of the ‘Acorn Stock Take’ will be covering the balance of our live and “bull pen” themes - everything from Canadian energy to drones and space, with a large side order of automotive linked themes.
As ever, please get in touch if you have any questions - via comments below, in The Drey or privately via DM (link below):
Squirrel out!
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