2020 June CAD

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2.25% MTD
2.92% YTD

Dear Partners,

For the month of June the Caravel Capital Fund Ltd returned 2.25%.

We are pleased with the fund’s performance for the first half of 2020. We managed to materially avoid the impact of a 30% drop in equity markets, and now have positive returns for the year to date.  For the month of June, the portfolio generated positive returns across all but one strategy.  Since the market’s rout in March, we have focused our efforts on building a multi-strategy book that can withstand severe systematic risk. 

Our mantra is “identify opportunities and manage risk” and we repeat it to ourselves daily.

We believe the risk of a negative systematic shock reoccurring is extreme.  As a result, the portfolio holds market neutral positions, selective alpha positions (naked short and naked long), and a substantial cash position.  The cash position is because we cannot find enough attractive risk adjusted return investments that meet our rigorous tests.  Don’t get us wrong, there are many ideas that are attractive on the surface, but when we overlay them with the current systematic risk, they don’t make sense.  Not to worry – as long as we are more than 10% in cash, the fund will remain closed to new investment.

We get running a deficit is part of government BUT it’s supposed to be no more than 2%-4% of GDP.  The United States 2020 budget deficit has not just pushed the country’s total debt past the point of no return, it has been shoved clear off the map.  The bill for the ongoing fiscal stimulus and the structural unemployment that will follow COVID-19 will materially reduce the future earnings of US companies, and individuals.  The math does not lie.  Some of the smartest guys running money share this view - Jeffrey Gundlach of Double Line ($135 Billion Hedge Fund), and Ray Dalio of Bridgewater ($160 Billion Fund) are two examples.  They didn’t get to be #1 and #2 in size by being wrong.  Below are links to two of their recent interviews for your reference.

Jeffrey Gundlach: Gundlach’s July 1st interview was a bit scary, but we highly recommend listening to it.  Jeffery is undeniably the best and brightest bond manager today.

Bridgewater Interview

So why does systematic risk concern us so much? Great question. There are three things that cause us serious concern and they are converging simultaneously, in a fully valued market.  We don’t see a way a collision can be avoided.

  1. A highly contagious virus is infecting people at an accelerating rate in the world’s largest economy.  The only known solution is to lock people in their homes, which means severely restricting the engine of that economy.
  2. The virus has killed 135,000 people in the US, largely as a result of poor leadership by a president who is pro-business.  That would not rattle our business compass if he wasn’t up for re-election in 3 ½ months… but he is.  The challenger is leading substantially in the polls and is odds on favorite in the gambling markets.  The challenger has promised to raise corporate taxes, which will likely wipe out the 23% stock market gain that Trumps corporate tax cuts generated.
  3. While all this is happening, the major economies have increased their debt at a rate not seen since WW2.  Most of this money was spent on fiscal stimulus, but the butcher’s bill will be enormous and may arrive at a time that all major economies are suffering a period of prolonged high structural unemployment.

The smart guys are calculating earnings per share next year for the S&P 500 at $145-$155.  The closing level of the SP 500 today was 3,015, which puts the market value at over 20 times 1-year forward earnings.  These are forecasts for NEXT year.  The stock market’s valuation is now higher than it was in February 2020. Recall we didn’t have structural high unemployment, increased corporate taxes, the 30-40% increase in G7 nations debt, or global pandemic.

So why is the market where it is?  Our best guess (shared by Gundlach) is the home gamers.  Let us explain.  During 2019 the discount brokerages in the US, and other countries announced to great fanfare the introduction of zero commission trading.  You can now buy or sell whatever stock you want with no commission charges.  In March and April of 2020, the discount brokerages began to experience 100%+ year over year increases in new account openings. Why you ask? Another great question (honestly as a client, all your questions are great but today you are asking some truly excellent ones).  With near full employment in February, it is fair to assume that many Americans had at least little cash saved.  Let’s assume first 20% of the 250 million workers in the US had some savings, next Uncle Donald gave them and every other person a few thousand in COVID cash, finally you locked them all in their homes for 16 weeks. No sports to watch or bet.  No friends to get together with. Literally out of boredom 10’s of millions of people opened discount brokerage accounts.  We estimate about $1.3 trillion of government money went right into the stock market. Well, wouldn’t you know it, up went stock prices.  These rookies must be good at this because in three months even the indexers are up 30%.  What could go wrong?

What do you think these new investors will do come August or September if big money decides the market has overshot the upside and becomes concerned with the real risk of a corporate tax hike?   We will tell you – the same thing they did in 2000 when the gig was up with Nortel, DrKoop.com, Worldcom, Broadcast.com, Bid.com, the list of the dead goes on and on.  Musical chairs is not an investment strategy in our offering memorandum.

On top of our market neutral portfolio, we have a sizeable market short position using options.  We continue to add to it, which is why our returns on a monthly basis are not as robust as we would otherwise expect.  We think it’s a good idea to be patient and see how the next several months play out.

We thank you for your continued confidence and capital,

Caravel Capital.

Monthly Performance (net of all fees)

JanFebMarAprMayJunJulAugSepOctNovDec YTD

Risk vs. Return Comparisons Across Indexes

Month Return YTD Return Volatility Sharpe Sortino Beta Best Month Worst Month Annualized
S&P 5001.99%-3.09%15.2%0.790.880.112.82%-12.35%11.94%

Growth of $1000 since inception

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