facebook twitter instagram linkedin google youtube vimeo tumblr yelp rss email podcast phone blog search brokercheck brokercheck Play Pause
The Market Telling Us How to Invest Our Money for Asymmetric Investment Returns Thumbnail

The Market Telling Us How to Invest Our Money for Asymmetric Investment Returns

Sometimes the markets tell us how to invest our money for asymmetric investment returns. It isn't so much short-term rates are an indicator or precursor to a stock market decline, but instead, as the perceived "risk-free rate," it's giving investors optionality. Optionality is essential for the asymmetric risk/reward that provides asymmetric investment returns. 

The short-dated U.S. Treasuries (the 13-week T-bill) reached a yield of 5%. 

When we chart the interest rate of these short-term treasuries we see interesting trends. The first thing I observe is the short term rate peaked in 1999, 2007, 2020, and so far in 2023. 

The Fed is expected to stop raising short term rates, so this may be the peak. 

But that's not the point here. 

I recognize 1999, 2007, and early 2020 as inflection points, tops, in the stock market. 

When we compare the shorter-dated U.S. Treasuries to the S&P 500 Index (red line), a representation of the stock market, we see rising interest rates peaked in 1999, just before the 2000-2003 bear market that lost ~50% over three years. 

By 2007, when the stock market indexes finally recovered from the decline that started seven years earlier, short-term interest rates were trending up again and peaked just before the stock market peaked. 

Afterwards, the S&P 500 declined ~56% to the March 2009 low. 

The Federal Reserve kept short term interest rates very low for the next seven years. 

But then the Fed's Federal Open Market Committee (FOMC) started raising rates again up until 2019. 

Rising rates and the Fed's attempt to unwind its unprecedented Quantitative Easing (QE) resulted in several volatility expansions for the stock market, with stock index declines ~20% in 2011, 2015, 2016, and 2018 that could be attributed to their attempt to get us off the pacifier. The Fed's pacifier became known as the "Fed Put" since the FOMC kept coming to the rescue when markets dropped by lowering rates and flooding the financial system with liquidity (more money.)

Back to the chart again, I labeled the first two interest rate peaks with a blue arrow to highlight the point of the S&P 500 overlay.

We see 1999 and 2007 rate tops coincide with stock market tops. 

But by 2019, the short term rates kept trending up through the stock market corrections 2015, 2016, and a big waterfall decline December 2018. 

Then came COVID. 

The correlations between high short-term rates and a peak in the stock market were obvious in 1999 and 2007, but more recently, after so many years of unprecedented bailouts, it seemed the euphoria driven by the expectation of bailouts (the Fed Put) didn't result in a ~50% bear market over the next few years, but instead several sharp corrections in the ~20% range. 

But COVID was different. 

Zooming in to a weekly log scale of five years, we see the 13-week U.S. Treasury rate peaked in 2019 and declined into 2020, then plummeted into the waterfall decline with the stock market. The S&P 500 dropped ~34% in just a few weeks. 

However, COVID alone wasn't the only driver of the crash. The stock market was already very extended and investors were extremely complacent. To be sure, see Now, THIS is what a stock market top looks like! I wrote January 2020. 

The intermarket relationship between short term rates and the stock market wasn't as clear as it was before, but I attribute it to the extraordinary optimism we hadn't seen since the last 1990s. 

There's a whole generation of investors who haven't experienced a prolonged bear market like 2000-2003 or 2007-2009. 

The Fed has stepped in to save the day, over and over, since 2008, and it's been a windfall for risk-taking passive investors who've held stocks or stock funds. 

With all the obvious reasons, such as the nation's debt soaring to all time new highs, something has to give. 

Back to the original visual of short-term rates and how it interacts with stock market peaks, what is the point I'm making here? 

This is only the 3rd time in 25 years the short-term T bill has reached 5%, and each time it pulled me into short-term U.S. treasuries/money markets.


Short-term U.S. treasuries/money markets are considered the "risk-free" rate. The risk-free rate of return is the interest rate an investor can expect to earn on an investment that carries zero risk.

There is no such thing as "risk-free" in the real world. The U.S. government could default on its debt, for example, and a default could impact the short-term U.S. treasuries/money markets investors expect to be without risk of loss. Investing always involves risk investors must be willing to bear, or hedge. 

Notwithstanding a default, when the so-called "risk-free" rate is 5%, it's the market telling me our investing and trading must exceed a higher hurdle of 5% for an asymmetric risk/reward. 

The risk/reward for the stock market isn't asymmetric at ~20x earnings, with ~5% inflation and US-backed 'risk-free' money markets at ~4.7% and the 13-week T -bill at 5%.

(a ~ tilde is used before a number to mean “about” or “approximately.”) 

We may start to see the lack of asymmetric risk/reward in the months or years ahead.

I've been thinking for over a year this could be a very long bear market if the economy enters a recession. It's already unfolding that way.

But, investing is always probabilistic, never a sure thing. 

By and large, institutional investors drive stock market trends. If you are managing a multi-billion dollar portfolio for clients, pension, endowment, or a business, you're probably using the Capital Asset Pricing Model (CAPM.) The risk-free rate is used in the calculation of the cost of equity (as calculated using the CAPM), which influences a business’ weighted average cost of capital. 

A rise in the "risk-free rate" pressures the market risk premium to increase because investors are able to earn a higher "risk-free" return, so riskier assets will need higher upside potential than before to meet investors’ new base rate for required/expected returns. In other words, investors (the market) sees other investments as relatively higher risk compared to the risk-free rate. So, to the extent investors are rational, they demand a higher rate of return to compensate them for taking higher risk.

Does the stock market seem risky right now? 

Of course it does.

There's no shortage of tail risks that could cause a downtrend or a crash. This week U.S. government leaders will negotiate the debt ceiling, and a default could be catastrophic. We don't know how it would unfold. It's a tail risk. Inflation is falling but still elevated, so we aren't certain the FOMC will (or can) stop raising rates. Further, economists don't yet know if the current interest rate level has choked off enough liquidity to drive a recession. Then there are the geopolitical issues with China, Ukraine, and Russia. It's still May, some sell in May and go away. 

You can probably see how relatively "risk-free" interest rates yielding ~5% are attractive. Relative safety is paying us for patience. 

I'm not the only one to feel the pull into short-term money markets.

According to Goldman Sachs, my firms broker and custodian, outflows from US equities has been $58 billion, inflows to money markets is $707 billion, and huge inflows into bonds and non-US (international) stocks.

Such a radical shift in the flow of funds out of stocks into money markets, bonds, and international stocks could be seen as a contrary indicator, we can follow the trend and go with the flow. 

As a Quant firm, we apply maths and science to data rather than coming up with good stories.

We employ scientific methods for testing and developing trading systems with a positive mathematical expectation, which gives us a statistical basis for believing in what we do. 

We focus on the direction, momentum, relative strength, and volatility of price trends. 

In 2023 the stock market trend has been up, but the "risk-free" investment is paying ~5%, so we pay attention to total return and asymmetric risk/reward. 

The probabilities, and expected return, for asymmetric investment return lean toward short-term interest rates. 

What we do know is large institutional investors and professional investment managers like Shell Capital have a decision to make: 

We can sit there with our sails out, waiting for the wind to blow us where we want to go, or we can get out the oars and start rowing.

Today, the short-term bond market is paying us to be patient as we stalk the markets for potentially profitable price trends.

We don't have to be fully invested all the time. 

We are unconstrained, flexible, and adaptive, as we focus on total return (gains + interest) in pursuit of asymmetric investment returns. 

The bottom line is, despite our investment and trading strategies being Quant, and focused on the price trend, which is the final arbiter, even we start to pay attention when the market offers ~5% on short-term funds because our systems factor in the yield for total return, making the base rate higher for other markets to exceed. 

The market is guiding us. We can get paid for not taking so much risk, and that requires our tactical trades to offer an even higher reward for the risk we take. 

While the "risk-free rate" is far from our only signal, we just have to follow the trends the market gives us. 

Mike Shell is the founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Managed Portfolios. Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as investment advice to buy or sell any security. This information does not suggest in any way that any graph, chart, or formula offered can solely guide an investor as to which securities to buy or sell, or when to buy or sell them. Securities reflected are not intended to represent any client holdings or recommendations made by the firm. In the event any past specific recommendations are referred to inadvertently, a list of all recommendations made by the company within at least the prior one-year period may be furnished upon request. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities on the list. Any opinions expressed may change as subsequent conditions change. Please do not make any investment decisions based on such information, as it is not advice and is subject to change without notice. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but are not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect the position of Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.