For the month of April, the Caravel Capital Fund Ltd was up 1.27%.
In our November letter following the US election, we saw significant upside in pockets of the market and informed you we were going to “let out some shaft”. That is a term my Dad used when he put our boat at full throttle. As kids, it was fun and exhilarating as we watched the speedometer climb. He was the Captain and understood it was his call when to throttle back. Similarly, we recognize we are the Captains of the Caravel Capital Fund Ltd, and hold the responsibility to “let out some shaft” when we see calm waters and strong visibility of what lies ahead. We had a remarkable first quarter and continue to harvest gains from our added risk. We hope everyone felt the exhilaration and enjoyed the ride.
In our March letter, we told you the Caravel Capital Fund Ltd began reducing its market exposure during the first 10 days in April. The fund purchased options that profit if the Nasdaq were to fall more than 4% and similar options that profit if the SP500 index were to fall more than 5%. In addition, we reduced holdings in our deep value book, added significant short stock to our warrant portfolio, sold much of our remaining oil & gas exposure, etc. Global stock markets are priced for perfection in terms of earnings, inflation, fiscal stimulus, and a sustained COVID-19 recovery. Some areas of the market reached levels well beyond even those rosey expectations.
At a minimum, we felt markets needed the fundamentals to catch up with share prices. That is what we are watching as we type this letter. The NASDAQ by far the most expensive and overbought index, which rose 10% by mid April and was back to flat on the year earlier this week. Other major indices are checking back and continue to plumb for levels of support. We will likely begin to cover some of our short market exposure over the coming weeks, unless a very different beast emerges. The one we have not seen for four decades, but has been the subject of many bear market letters - inflation.
In December 2019, we had positioned the fund similarly to our April 2021 move due to excessive economic optimism and what we viewed as an elevated valuation of securities. The economy in the US was running hot from Turmp’s tax cuts, relaxed regulation, revamped trade deals that encouraged isolationism and continued improvements in productivity (think how much Amazon has improved our personal productivity). The financial press was bursting with articles explaining how well the global economy was doing. Then we had COVID-19. In March of 2020, no one alive was an adult during the last global pandemic and no one had any idea what the future held. Equity markets collapsed, and then came the monetary stimulus… Trillions - Then came fiscal stimulus - Trillions. Global governments poured enormous amounts of money onto an economy that had only paused. We have now overstimulated so much, that demand for goods and services is eclipsing supply regardless of technological improvements to productivity.
In case you’re thinking “why don’t central banks just pause the fiscal stimulus?” they can’t! No one, meaning no Sovereign wealth fund, Life insurance co, Investment fund, Private wealth, Pension fund, Endowment or Retirement account (S.L.I.P.P.E.R.’s) can lend large amounts of money at interest rates below the level of inflation in the face of an increasing inflationary cycle. The only buyers of all this debt from the government’s stimulus is the Central Banks themselves. The Bank of Japan now buys 80% of all Japanese sovereign debt, and the Federal Reserve bought 54% of the bonds the US Government sold this year. The same or worse is happening in Europe and Canada. Why don’t we let interest rates rise to a point where the SLIPPERS come back? Because Central Banks need to keep long term rates low enough that their federal governments can afford to pay the interest on all this debt. Years ago, we wrote that if Japan’s long term interest rates rose past 1.2%, the country would be insolvent. The US has entered this realm now. Not 1.2%, but a 4.9% 10 Year bond, which the US congressional budget office forecasts, will require 30% of all US government revenue, just to pay the interest.
So how does this affect the stock market? When SLIPPER’s decide not to purchase new government bonds as their old bonds mature, Central Banks are forced to buy these new bonds to avoid letting long term interest rates rise. The Central Banks print currency to do this, lovely new money smell and all. This new money is given to the government who issued the bonds. The government then gives it to the SLIPPER’s who hold the maturing bonds. And presto – we have just increased money supply. What is the impact of this? The SLIPPER’s now have more cash than they were budgeting, so they start buying other assets, like stocks, real estate and commodities. This pushes those prices up, eventually to points that are unjustified. We call this priced to perfection. Now consider inflation. Inflation raises input costs for companies. This leads to compressed margins and lower profits in the near term. What happens to stocks that are priced for perfection when profits don’t keep up? Houston, we have a problem. A really nasty one.
The only way we have avoided this problem for 41 years has been through increasing productivity with technological advancement. Think the PC in the 80s, then the Internet in the 90s, then ecommerce since 2005. These innovations have allowed companies to produce goods and services more and more efficiently, keeping inflation, as it is converntionally measured, at bay. Our fingers are crossed, and our hedges are in place.
We would like to share with you one of the most genuine and informative interviews we have seen in years. Stan Druckenmiller was George Soros’s portfolio manager from 1988-2000. He is one of the smartest and wealthiest men who ever managed money. He now just manages his own billions. So, this interview isn’t to get clients, it’s a public service announcement. And it’s worth every second of your time.
In the month of April all performance fees will were re invested into the fund. On May 1st Jeff redeemed 500,000 from his holdings to continue building his house and still remains the second largest investor in the Caravel Capital Fund Ltd.
We thank you for your continued confidence and capital
Glen & Jeff - Caravel Capital
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