Risk/reward in the stock market: Three Body Problems and Hic Sunt Leones.

Gavin Baker
4 min readJun 11, 2020


The “Three-Body Problem” is a reference to Poincare’s 1889 work showing that there was no closed form solution for modeling three point masses (planets or moons) according to Newton’s laws of motion and universal gravitation as the resulting dynamic system is chaotic for most initial conditions. It is also a fantastic science fiction novel by Liu Cixin. The market faced a three-body problem in late February and now faces one again. Political risks, virus risks and economic risks are again converging.

In late February, the market faced the prospect of Bernie Sanders as the Democratic nominee, rising Covid-19 cases and the risk posed by Covid-19 to the economy. All of these risks were effectively eliminated during March and early April as Sanders lost on Super Tuesday, new cases peaked and the government implemented the most aggressive combined fiscal and monetary stimulus in history. The combination fueled the greatest 50-day stock market rally in history. Unfortunately, the market now faces a three-body problem again.

Prediction markets currently favor a Democratic sweep of the House, the Senate and the Presidency. This is a significant risk to the market, which generally does best with a divided government (Democratic President and Republican Congress is the best combination historically).

New virus cases are accelerating outside of NY state and we have yet to see the impact of Memorial Day and the protests. The protests are an eerie echo of the bond parades that helped to spread the Spanish Flu in 1918. Many believe that an acceleration in new cases is irrelevant and will not matter to the market. This belief fails to account for the underlying health care reality of limited ICU capacity that drove the original rationale for lockdowns. If ICU utilization goes over 100%, it is likely that we will have much more significant and extended lockdowns. We are beginning to see signs of this in Arizona, where ventilated Covid-19 patients have increased by 400% since reopening, according to Banner Health, Arizona’s largest medical network. As of June 8, 76% of ICU beds were occupied.

Fiscal stimulus benefits will begin to dissipate over the next few months and it seems unlikely that the next round of stimulus will be enacted as quickly and readily as the first round. Many small businesses in my neighborhood have already shut down permanently and CEOs say that they are not planning on bringing back all of the workers that they had to lay off.

This leaves the Fed. “Don’t fight the Fed” is a widely acknowledged maxim for a reason — but the risk/reward in the market seems significantly worse relative to a month ago. Real money sentiment indicators like the put/call ratio are at extreme levels and retail investors are participating to an extent not seen since the late 1990s. On the other side, as @modestproposal1 has pointed out, rallies of this magnitude almost always lead to new highs one year later but the sample set is very small. And while many sentiment indicators are becoming overheated, positioning is still reasonably cautious and most of the professional investors that I know are not fully invested.

I think it is unproductive to try to forecast the market. It is factually correct that “time in the market is more important than timing the market” and to quote Peter Lynch, “far more money has been lost by investors trying to anticipate corrections, than lost in the corrections themselves.” The Federal Reserve has more information about the economy than any market participant, hundreds of PhD economists with which to model the economy and control of the most important dependent variable, the price and quantity of money. Despite all of these advantages, the Fed has statistically zero ability to forecast the economy out more than a few quarters at most. So for me, opining about the market’s likely direction is a guilty and ultimately fruitless pursuit similar to reading US Weekly — I know it’s a waste of time but I cannot help myself from reading it when it is in front of me. Nor can I prevent myself from having opinions about the market even if I rarely act upon them given that I am fundamentally driven, bottoms up investor with a long-term time horizon.

More to the point, there are always a multitude of good reasons to be bearish and fewer to be bullish yet optimism has always paid over the long term. The “wall of worry” always exists. Still, the range of outcomes for the market feels unusually wide right now and I am trying hard to stay flexible. I was reasonably cautious towards the top in late February/early March, reasonably constructive towards the bottom in late March and have grown more cautious over the last two weeks. From a bottoms up perspective, there are fewer stocks that I am super excited to buy and I am becoming more focused on long-short opportunities.

So rather than engage in the futile exercise of trying to predict near term movements for the stock market, I will say only that I think risk/reward has deteriorated and “Hic Sunt Leones.” This was written on Medieval Maps to denote areas where the Cartographer had no knowledge. This phrase literally means “here be lions,” but was commonly understood to mean “here be dragons.” It is also the motto of house Augustus in Pierce Brown’s excellent Red Rising series. So: “Hic Sunt Leones.”



Gavin Baker

Founder, CIO & Managing Partner, Atreides Management LP. Former Portfolio Manager, Fidelity OTC Fund. No investment advice, views his own. More: gavinbaker.net