Dear Partners,

For the month of February, Caravel returned -0.66% compared to -0.85% for the benchmark (-1.31% for the S&P 500 & -0.40% for the SPTSX)¹. This brings year to date total net return to +1.54% for the fund and +2.25 % for the benchmark, respectively.

Stock market gains in the first half of February were erased late in the month as global trade tensions escalated with little clarity on the outcome. When investors are faced with a highly uncertain landscape on an issue as consequential as trade, they typically respond by ‘de-grossing’, which began in late February and has continued into March. As we noted in our December 2024 Letter, we believed US stocks were priced near perfection coming into 2025, then sporting a forward earnings yield of 4.44% compared to a 4.65% yield on US 10-year treasuries. About this dynamic, we said:

“We believe something needs to give, and either US bond yields or US stock market multiples (or possibly both) are likely to trend lower from here.”

Since then, the 10-year treasury yield has decreased to 4.3% and the forward earnings yield on the S&P 500 has increased to 4.8% (i.e. the P/E multiple has contracted by 1.5x). As such, the equity risk premium has swung from -0.21% to +0.50%. We would say this is a good start for those looking to increase their allocation to US stocks, but who have been waiting for a more compelling entry point than has been on offer in recent years.

Though it seems likely that no country will be safe from President Trump’s plan to re-draw the economic maps of the globe, Canada has to this point been the counterparty towards whom he has been most contentious. For example, as it currently sits the United States plans to impose higher tariffs on Canada (25%), its closest global ally than on China (20%), its fiercest economic and geopolitical rival. While we share many fellow Canadians’ confusion regarding this topic, we have tried to position our portfolio pragmatically and unemotionally.

On this point, the fund’s losses in our equity long-short (-2.0%) and commodity (-0.5%) strategies were partially offset by gains in our hedges, credit securities and merger arbitrage positions (+1.9% collectively). We spent most of February reducing or divesting long positions in equities with material tariff risk, which we spent weeks assessing on a company-by-company basis. As a result, we have brought the net exposure of our equity long-short book from +30% to +15%, and used the proceeds to increase our allocations to hedges and market neutral strategies. At the time of writing, this repositioning has paid off and we’ve managed to navigate the continued volatility in March with relative comfort.

We are not sure if the stock market has found a near-term bottom, but suspect we are unlikely to reclaim old highs without a significant de-escalation of trade tensions between the US and the rest of the world. As such, we intend to maintain a defensive posture until we see some ‘all-clear’ signs, which in our view could come either in the form of A) new trade deals or B) the market fully pricing in the economic impact of the ‘worst-case scenario’, which at present is still very much on the table. This would likely come in the form of meaningful downward revisions to earnings estimates, low or negative real GDP growth, an increase in developed market unemployment rates, and (lastly) a Fed pivot, which would likely set the stage for the next phase of the bull market. 

We know times like these can be stressful. If any of our partners would like to check in with us at any time, we’d welcome the chance to catch up. We continue to work diligently to manage risk, separate signal from noise, and deploy capital using the same framework that has served us well over the past eight and a half years at Caravel.

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}