Is Bitcoin A Useful Measure Of Risk Sentiment For The Stock Market?
By James Picerno | The Milwaukee Company | jpicerno@themilwaukeecompany.com
Bitcoin’s value remains limited for conventional use for purchasing goods and services, but there’s a growing focus on the cryptocurrency’s volatile price trend as a measure of the general appetite for risk in financial markets.
The rising correlation between returns for bitcoin and the US stock market show a closer relationship between the two assets in recent years.
This year’s downturn for the S&P 500 appears have been foreshadowed by bitcoin’s correction, which started earlier.
The use case for bitcoin remains debatable, although there’s a growing focus on the cryptocurrency’s volatile price gyrations as a potential indicator of the risk appetite for the equities market and beyond.
As the latest example, bitcoin began turning lower in mid-February while the stock market (S&P 500 Index) was at or near record highs (see chart below). This could be random behavior, but reviewing the return correlation between equities and bitcoin shows a closer relationship in recent years.
The second chart below shows the rolling 1-year correlation for daily returns for the S&P and bitcoin. The linear trend since 2015 highlights a rising connection. The correlation between the two assets is currently around 0.4, which equates with a moderately positive relationship. By comparison, before 2020, the correlation remained below 0.2 and was, at times, negative.
The closer link between the two assets suggests that bitcoin tends to be subject to the same risk-on and risk-off cycles as stocks. As such, to the extent that bitcoin has been a hedge for stock market risk, the efficacy of the hedge appears to be fading. At the same time, bitcoin’s wider and deeper integration into the financial eco-system (albeit primarily as a speculative asset to date) seems to be enhancing the cryptocurrency’s price trends as an early indicator of changing risk sentiment.
What’s the catalyst for bitcoin’s rising correlation with the stock market? The asset’s growing integration into the financial system is one possibility. As bitcoin has become an increasingly mainstream market (the launch of bitcoin ETFs and higher institutional allocations, for example) its short-term trends appear to have become more closely aligned with general investment flows.
Although bitcoin is now more widely held and traded across the financial world’s ecosystem, one thing hasn’t changed for the asset: relatively short, dramatic trend cycles. As the third chart shows, the 6-month return history remains volatile. The extremes of a decade ago have subsided to a degree, but the hefty swings endure (at least by the standards of conventional assets).
Because bitcoin remains heavily influenced by speculative investment flows, the ebb and flow of its price trends remain stark. Meanwhile, the cryptocurrency’s market cap has surged and was recently estimated at roughly $1.5 trillion, which is more or less equivalent to the total market value of Meta (Facebook). As a result, bitcoin’s price-trend shifts probably reflect a wider share of market sentiment generally.
It’s open for debate how bitcoin’s role as an asset will evolve in the years ahead, but there’s a case for monitoring the price as a possible early sign of change in the market’s near-term appetite for risk.
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