2020 December CAD

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3.15% MTD

15.02% YTD

Plan your Work, then Work your Plan

Dear Partners,

For the month of December the Caravel Capital Fund Ltd was up 3.15%

After a year unlike any we have previously experienced, stating  what is known will serve us well before providing any prognostication. From the knowns, we find our go forward plan for 2021. 

1. The Standard and Poor's 500 index is currently valued at 23.4 times the average forecasted earnings for calendar year 2021 and 20 times average forecasted earnings for 2022. These estimates would require corporate earnings to rise +25% in 2021 and then +15% in 2022.
2. The cost for the United States to borrow money has doubled since the lows in March of 2020. However, it still only costs them 60% of the US Central Bank’s long term target of 2% inflation. Put another way, it pays for them to borrow money.
3. The U.S. electorate has instructed its Federal Government to pivot fiscal stimulus away from lower taxes (Reaganomics) to more direct spending through social assistance and infrastructure rebuilds (New Deal).
4. The scientists project (the known comes from the smartest guys we all went to school with) it will be between June and September when the developed world will have been sufficiently inoculated against Covid-19 virus for business to operate “normally.” (Re-read known fact #1, but put down your glass of wine first).
5. The cash that has built up in checking accounts, the restocking of store inventory and the pent up demand to consume soft and hard goods equates to a 7-15% increase in the developed world's 2020 GDP. It’s a perfect set up for a very hot economy in late 2021.

Over the past nine months, Caravel has relied on known facts to provide the foundation for our return in 2020, and equally important allowed us to avoid a massive drawdown in Q1. We expect this same approach will serve us well in the future. However, we did not start 2020 with the above knowledge, in fact nine months ago Caravel pivoted and embraced change.

“Change before you have to.”   - Jack Welch

Adapting to change is essential for a successful business. Adapting before you have to is what separates the good from the great. For much of his career, Warren Buffett avoided making investments into companies that didn’t fit into his value template. It was only after long conversations with his partner Charlie Munger that Berkshire bought Coca-Cola in the late 80’s, a more growth oriented stock. More recently his  friend Bill Gates convinced him after 2009 to pivot and look at tech companies that both fit his rigorous standards and had strong growth prospects. From 2016 to 2018 Berkshire bought 960 million shares of Apple. They paid $30 Billion for it.  Yesterday that investment was worth $130 billion, Buffett’s biggest gain on any one investment in his almost 70 year career. Change before you have to, indeed.

Caravel is a market neutral fund. We endeavour to execute on our mantra: “above market returns with below market risk.”  In early 2020 we identified risk and acted before we had to. We were rewarded like the other funds that took defensive stances into a frothy market. What separated Caravel was our knowledge that when governments put their shoulder into affecting change, CHANGE COMES. 

In March and April we changed before we had to:

1. We bought out of the money call options on major US and Canadian stock indices. A lot of them.
2. We started looking for distressed opportunities that were not a result of bad businesses but from bad management and took activist positions.  We saw the chance to remove management and restructure companies in the downturn.
3. We took positions in attractively valued gold companies knowing big stimulus would push gold higher. We purchased more through financings that included warrants.
4. We shorted mergers with exposure to closing conditions and obvious buyer’s remorse, and watched most of those deals break or trade substantially lower than the offering price.
5. We continuously reviewed the portfolio, sold positions when our thesis didn’t play out and changed focus to things that offered protected upside.
6. We saw long bond yields collapse and invested in companies that benefited from these lower rates and debt refinancings.
7. For six months, we watched the price of oil trade below the level needed to supply moderate global economic activity. We waited patiently and by September we were confident vaccines were on the horizon. We  invested in oil producers that were profitable below the minimum oil price required to sustain demand. We then added long dated call options on oil itself. I like to call this The Grizzly trade: You don’t have to outrun the bear, just the slowest guys with you. The oil call position has a 10:1 payoff if oil trades above 60. Since we entered this trade, oil has risen from $38 to $53 per barrel. Stay tuned!

We believe 2021-2022 will see a steady and lengthy rotation from high multiple growth stocks into value trades as the 5 knowns we listed above take effect. We know 10 year rates have a cap at or below the Federal Reserves targeted  2% average inflation rate. Increasing the cost to borrow from 0.50% for 10 years to 1.50%-2.00% lowers the value of growth companies’ future earnings substantially. When 10 year money costs 0.50% per year, the present value of their future earnings is almost equal to the sum of their actual earnings (all other things being held equal). Most of a growth company’s earnings show up 5-10 years in the future, so based on their current small earnings, the multiple the shares trade at today seems elevated. If 10 year rates were to move up however, growth company’s values drop the most - simple math. Higher interest rates lead to a steeper discounting of far-in-the future cash flows. Think downside on Zoom, Tesla, Shopify, etc. We believe valuation multiples will drop for growth names as their share prices fall or stay the same, and will rise for value names as corporate earnings massively rebound later this year into a hot economy... so in the words of Sheryl Crow, “A change would do you good.”

We see incredible opportunities this year in the markets for Caravel’s investors. As we mentioned in our November letter, we have decided to reopen the fund and accept new investments for February 1^st. We will be reaching out to determine current investor interest prior to accepting capital from new investors who inquired while we were closed. We will be accepting up to C$ 40 million.

We thank you for your continued confidence and capital,

Glen & Jeff - Caravel Capital