Dear Partners,

For the month of July, Caravel returned +1.96% compared to +1.97% for the benchmark (+2.24% for the S&P 500 & +1.69% for the SPTSX)¹. This brings year-to-date total net return to +13.30% for the fund and +10.33% for the benchmark, respectively.

Our July performance was driven by equity long-short (+1.6% gross), merger arbitrage (+0.5% gross), fixed income/converts (+0.5% gross), and commodities (+0.3% gross), while the fund’s shorts and hedges cost us approximately 0.5%. We have continued to roll and extend our hedges as the market has sharply recovered from the April 2025 lows and continues to press all-time highs.

Many of the same themes that have been driving the North American capital markets since late 2022 continued in July. These include massive earnings growth and high multiples among a small but elite group of technology stocks in the US, with the S&P 500 now trading at 21-22x 2026 estimated earnings, and a catch-up trade in Canada after years of underperformance. In fact, the SPTSX has outperformed the S&P 500 by 16% since we flagged the value divergence and noted our preference for Canadian stocks in our May 2024 Letter. The index is now trading at 15-16x 2026 estimated earnings, despite having a similar expected growth profile year-over-year relative to its US counterpart. Of course, these earnings growth expectations are based on the current analyst consensus, which has historically had little predictive power 18 months into the future. All of these things we have written about before (and we still prefer Canadian stocks). We try to keep these letters fresh and as thought-provoking as possible. In the interest of this pursuit, we’d like to spend some time on a story we’ve been watching closely in recent months.

The Powell Problem

Since taking office a second time (and even before that), President Trump has been using his considerable platform to publicly pressure Federal Reserve Chair Jerome Powell. The crux of the President’s grievance seems to hinge on the Fed’s decision to hold its target overnight interest rate steady since December 2024, just before Trump took office, after cutting it by 1% leading up to and shortly after the 2024 election. We are certain that Trump views this decision as political; that the policy easing in late 2024 was an attempt to get the Democrats re-elected while the inaction this year has been intended to sour the economy over which he is presiding. Whether Trump has a point here is something only known by the members of the Federal Open Market Committee (FOMC), the policy-making arm of the Fed. Aside from seeing a political enemy in Powell, there are other potential justifications for the President exerting pressure on the Fed in pursuit of lower interest rates. For example, the Fed’s policy rate does tend to influence the short end of the yield curve, or the yield investors demand for short-term US Federal Government Treasury securities. In the context of a ballooning federal debt, it is in the US Government’s interest to, all else being equal, minimize this yield, as it is the cost they pay to finance their persistent budget shortfalls. This is what we would characterize as ‘first order thinking’ 🡪 lower interest rates = cheaper treasury debt = lower interest payments = smaller budget deficit. These are all stated objectives of Trump’s administration and, in our view, worthwhile pursuits.

There has been much speculation about the possibility of Trump announcing Powell’s replacement any day. Powell’s term is set to end in May 2026. It would be atypical for a replacement to be announced this soon. The result of such an announcement would be predictable in some ways. Markets are forward-looking, so it would be reasonable to expect the financial media and investing public to immediately swarm the new candidate in order to feel them out. We think, however, there would be little suspense in such an exercise. Given Trump 2.0’s proclivity to fill every discretionary position in government with people who, above all else, demonstrate loyalty to him and his agenda, it is likely that any ‘shadow-chair’ announced in the coming days or weeks would simply be the most dovish and faithful person that the Prsident believes he could get into the chair.

The ‘second-order’ thinking on this point is, what happens to US treasuries and the US dollar if the market believes the central bank has lost its independence from the federal government? There have been many historical examples of this, including Germany in the 1920’s and England in the 1940’s. Both of these cases, as well as others, led to periods of elevated inflation or hyperinflation. This is due to governments’ tendency to vote themselves (and their constituents) all the money to address short-term problems at the expense of long-term ones. It’s not difficult to imagine which of the two Trump, who will turn 80 next year, is focused on. The historical parallels have caused many to fear the announcement of a ‘shadow-chair’.

Where do we sit on this issue? 

Being an investor in the age of Trump has mandated that we must always be comfortable with an elevated level of uncertainty. The future is always uncertain, but in Trump we have a uniquely chaotic agent in the most important office in the world. One thing that gives us some measure of comfort on the issue of the next Fed Chair is that, no matter who the President nominates, they must also be confirmed by the Senate. With only 4 dissenting votes needed to block any such initiative, we believe the market’s worst fears (e.g. Fed Chair Baron Trump) are highly unlikely to materialize. More likely, the next Fed Chair will be someone who is outspokenly dovish while still having enough credibility to make it into the seat. This may still lead to higher inflation expectations going forward, but we would not, and are not, making asset allocation decisions based on the end of Fed independence, de-dollarization, or hyperinflation in the US. We have expressed this view in the form of a trade, going long stocks with positive exposure to lower interest rates.  In one such investment the fund purchased call options in a homebuilder's stock.  At the time of writing, we have partially monetized this trade, initiated in early July, at a healthy profit of +200%. We will continue to look for ways to express our views while preserving capital and minimizing our overall exposure to market volatility.

We hope all our partners have enjoyed their summer, and we look forward to updating you on our progress in the near future.

We thank you for your continued support,

Jack and Glen

Managing Partners, Caravel Capital

 _{1 Benchmark = 50/50 weighting of S&P 500 & SPTSX Composite Indices}