Why bitcoin is so highly correlated with the stock market? A deep insight

Dan is a data analyst at invezz and combines quantitative skills and a macroeconomic background to provide analysis on a range of… Read more.

It's been a turbulent year in the markets, to say the least.

But one thing that I think is both pessimistic and optimistic is the correlation between bitcoin and the stock market. This sounds strange, but let me explain.

Decoupling from the stock market is the best case for bitcoin

Many bitcoiners believe it's only a matter of time before bitcoin decouples from the stock market, spreads its wings and claims the previously elusive title of "hedging".

Undoubtedly, this is the best case – bitcoin's hard supply cap, bypass of government control, and its unique ability to separate money and government mean that the bulls' vision is enticing.

But if you look at the data, the correlation between bitcoin and the stock market is as high as it's ever been; this utopian (or dystopian, depending on what you think!) future never seemed further away. I plotted the correlation from the beginning of the year to today, and the results are revealing (for the nerds: I chose pearson's 6-month rolling coefficient as the measure).

For those who are less familiar with correlation, a coefficient of 0 means no correlation. For example, the correlation between the number of apples you eat on a given day and the frequency with which british prime minister lizz truss changes her mind is (probably) close to zero.

A correlation of 1, on the other hand, is perfect. So the correlation between the number of beers you drink and your level of sobriety is close to +1. It also follows that -1 is a perfect negative correlation, d. H. The correlation between the number of beers drunk and sobriety level is probably close to -1.

The closer the number is to 1, the stronger the correlation is. The closer to -1, the stronger the correlation in the opposite direction. And zero or somewhere close to it means there is no meaningful correlation. So it is a sliding scale between -1 and 1.

Let's look at the chart for the correlation between bitcoin and the stock market by taking a closer look at the time period 2022.

The correlation of bitcoin and the stock market has never been so high

It is immediately apparent that the correlation jumped at the end of january/february before increasing even more in april. In fact, the correlation was close to 1 for much of the year, with the markets moving in lockstep.

And what is unique about this year? Well, it is the interest rate environment. The U.S. Federal reserve has sent markets on a joyride with its aggressive stance on interest rates. The higher interest rates are raised, the more liquidity is removed from the economy and the more bearish it becomes. Too much increase in interest rates leads to the R-word: recession.

The fed has set a new paradigm in motion as inflation has spiraled after a decade of money printing, quantitative easing and near-zero interest rates. After COVID raised all this to a new level, inflation went wild. This is the keyword for the interest rate hikes with which the fed is trying to curb inflation again.

So let me add to the previous chart a variable that shows the increasing correlation between bitcoin and the stock market. Take a look at the rolling correlation with the fed rate in this:

Hmm. And remember – bitcoin wasn't launched until 2009, a year after the global economy collapsed, when bankers lost their minds and the subprime mortgage crisis in the U.S. Triggered one of the worst financial crises of all time. Since those dark days, the market has absolutely soared and experienced one of the longest bull markets in history. This was the era of low (negative?) interest rates and the quantitative easing that came with outrageous wealth gains.

COVID was the same, only on steroids. One of the most revealing graphs is the following – from my analysis of money prints and inequality published yesterday).

And then the bottom graph showing the extent of the stimulus compared to 2008. It's like comparing apples to genetically modified, enlarged oranges.

Against this background, it makes perfect sense that the correlation is so high. COVID flushed the whole system with cash, and then came inflation. Now the fed wants to suck all that back out – the worst news imaginable for the markets.

All that really matters right now are the words of jerome powell (I recently wrote here about the market's dependence on it). Markets react to expectations of future rate hikes, straight from powell's words, and to the monthly CPI report.

And what is the old saying? Well, correlations go up in a crisis to 1. Investors are looking for the safest assets and dumping everything to preserve liquidity. This is indeed one of the main reasons for the immense strength of the dollar this year, which I analyzed at the beginning of the year. Everything is connected.

Looking at the analysis of the dollar strength at the beginning of this year, one of my favorite graphs is the following, showing the dollar strength in the past and highlighting the crisis periods. Do you notice anything?

Bitcoin's first crisis

Again, nothing is surprising:

Step 1: unprecedented money pressure. Assets rise sharply, with those further out on the risk spectrum (tech stocks, bitcoin, dogecoin, etc.), more profits.

Step 2: as a result, inflation skyrockets.

Step 3: the federal reserve is pursuing an aggressive interest rate policy to contain inflation.

Step 4: assets are sold, with those that are further out on the risk spectrum (tech stocks, bitcoin, dogecoin etc.), suffer greater losses.

And – very important – the sellers do not make a difference. The selling is widespread, so correlations are rising, which is what we are seeing with bitcoin. It's not necessarily that the stock market is leading bitcoin; it's that there's a lurking variable – the U.S. Federal reserve – that's leading them both. Take another look at the chart above comparing the fed rate to the correlation between the S&P 500 and bitcoin.

And that's why I've been banging my head against the table all year (is that an expression?) to point out a misconception: the claim that crypto and bitcoin have been around before. Proponents argue that this is just the latest of many declines in cryptocurrencies.

That is not true. Bitcoin was launched in january 2009, which means that it exists for the first time during a macro bear market. Previous crypto winters took place amid the low interest rate environment where all was well in the world.

Today, power outages are expected on cold nights in london this winter. The share prices of the big technology companies have fallen by more than 70%. People struggle to afford milk and bread. So no, crypto has never been there before. Economically, these are dark times. And cryptocurrencies have never known dark ages.

How does it continue?

I am not saying crypto will not do what it has always done – recover. I'm just saying that this is not the friendly crypto winter from the neighborhood, but a different animal altogether – driven by the macroeconomic bloodbath, with correlations rising accordingly.

Let me return to the first paragraph of this article when I said that bitcoin's growing correlation is both pessimistic and optimistic.

In the long term, bitcoin must decouple to achieve its "goal" of becoming a store of value; an exit from the government-controlled world of fiat money. It's hard to argue. And in that sense, the extremely high correlation that has risen so sharply this year is disappointing. Certainly bitcoin will have no hope in the long run if it does not give up this dirty habit of volatility and refusal to do anything without holding the hand of the stock market.

The reason I say it's also a bit optimistic is that it shows that bitcoin is now a mainstream financial asset. In the past years there was a bitcoin that did not correlate excessively with the market. It was a nerdy magic money thing on the internet, something their friend's older siblings told them at a barbecue party.

Liquidity was low and there was no impact on the financial market in general.

But now it is there. Acceptance has risen rapidly. In the media, it is displayed alongside the dow jones and gold when it comes to daily market movements. The correlation confirms this – it moves more than ever with the stock market.

The next step is to eliminate this correlation. And if you look at bitcoin's fundamentals, which are more like a commodity than a stock (the opposite of ethereum, by the way), it has what it takes to do so. The real question is whether people recognize this and begin to evaluate it as such.

And that's what makes it so fascinating as an asset class. We have never seen anything like it – a kind of commodity that lives in the digital world. For this reason, the range of results is probably wider than for any other asset.

Whatever happens, it's going to be a fun ride. But the numbers show that bitcoin right now is nothing more than a stock market toy to be thrown around at will.

  • The correlation of bitcoin with the stock market has increased immensely this year
  • Both are affected by the federal reserve's interest rate plans
  • Bitcoin has never experienced a recession, which investors are overlooking

It's been a turbulent year in the markets, to say the least.

But one thing that I think is both pessimistic and optimistic is the correlation between bitcoin and the stock market. This sounds weird, but let me explain.

Are you looking for quick news, hot-tips and market analysis? Then sign up for the invezz newsletter today.

Decoupling from the stock market is the best case for bitcoin

Many bitcoiners believe it's only a matter of time before bitcoin decouples from the stock market, spreads its wings and claims the previously elusive title of "hedging".

Without a doubt, this is the best case scenario – bitcoin's hard supply cap, bypassing state control, and its unique ability to separate money and state mean that the bulls' vision is enticing.

But if you look at the data, the correlation between bitcoin and the stock market is as high as it has ever been; this utopian (or dystopian, depending on what you think!) future never seemed further away. I have plotted the correlation from the beginning of the year until today, and the results are revealing (for the nerds: I have chosen the rolling 6-month coefficient from pearson as a measure).

For those less familiar with correlation, a coefficient of 0 means no correlation. For example, the correlation between the number of apples you eat on a given day and the frequency with which british prime minister lizz truss changes her mind is (probably) close to zero.

A correlation of 1 on the other hand is perfect. So the correlation between the number of beers you drink and your level of sobriety is close to +1. It also follows that -1 is a perfect negative correlation, d. H. The correlation between number of beers drunk and sobriety level is probably close to -1.

The closer the number is to 1, the stronger the correlation. The closer to -1, the stronger the correlation in the opposite direction. And zero or somewhere near it means there is no meaningful correlation. So it is a sliding scale between -1 and 1.

Let's look at the diagram for the correlation between bitcoin and the stock market by taking a closer look at the period 2022.

Bitcoin and stock market correlation has never been so high

It is immediately apparent that the correlation jumped at the end of january/february, before increasing even further in april. In fact, the correlation was close to 1 for much of the year, with the markets moving in lockstep.

And what's unique about this year? Well, it's the interest rate environment. The U.S. Federal reserve has taken the markets for a spin with its aggressive stance on interest rates. The higher interest rates are raised, the more liquidity is removed from the economy and the more bearish it becomes. An excessive increase in interest rates leads to the R-word: recession.

The fed has set in motion a new paradigm as inflation has spiraled after a decade of money printing, quantitative easing and near-zero interest rates. Now that COVID has taken all this to a new level, inflation has gone wild. This is the keyword for the interest rate hikes that the fed is trying to use to curb inflation again.

So let me add to the previous diagram a variable that shows the increasing correlation between bitcoin and the stock market. Take a look at the rolling correlation with the fed rate in it:

Hmm. And remember – bitcoin wasn't launched until 2009, a year after the global economy collapsed, when bankers lost their minds and the subprime mortgage crisis in the U.S. Triggered one of the worst financial crises of all time. Since those dark days, the market has soared and experienced one of the longest bull markets in history. This was the era of low (negative?) interest rates and quantitative easing, which has been accompanied by outrageous asset gains.

COVID was the same, only on steroids. One of the most revealing diagrams is the following – from my analysis of money printing and inequality published yesterday).

And then there's the bottom graph that shows the extent of the stimulus compared to 2008. It's like comparing apples to genetically modified, enlarged oranges.

With this in mind, it makes perfect sense that the correlation is so high. COVID flushed the whole system with cash, and then came inflation. Now the fed wants to suck all that back out – the worst possible news for the markets.

All that really matters at the moment are the words of jerome powell (I recently wrote here about the market's dependence on this). Markets react to expectations of future interest rate hikes straight from powell's words, as well as the monthly CPI report.

And what is the old saying? Well, correlations go up in a crisis to 1. Investors look for the safest assets and dump everything to maintain liquidity. This is indeed a major reason for the immense dollar strength this year, which I analyzed at the beginning of the year. Everything is connected.

Looking at the analysis of dollar strength earlier this year, one of my favorite graphs is the following, showing dollar strength in the past and highlighting crisis periods. Do you notice something?

Bitcoins first crisis

Again, nothing surprising here:

Step 1: unprecedented money pressure. Assets are rising sharply, with those further out on the risk spectrum (tech stocks, bitcoin, dogecoin, etc.) being the most expensive.), record more profits.

Step 2: as a result, inflation skyrockets.

Step 3: the u.S. Federal reserve is pursuing an aggressive interest rate policy to curb inflation.

Step 4: assets are sold, with those that are further out on the risk spectrum (tech stocks, bitcoin, dogecoin, etc.), suffer greater losses.

And – very important – the sellers make no difference. Sales are widespread, so correlations are rising, which is what we are seeing with bitcoin. It's not necessarily that the stock market leads bitcoin; it's that there's a lurking variable – the U.S. Federal reserve – that leads them both. Take another look at the chart above comparing the fed rate to the correlation between the S&P 500 and bitcoin.

And that's why I've been banging my head against the table all year (is that an expression?) to point out a misconception: the claim that crypto and bitcoin have been around before. Proponents argue that this is just the latest of many declines in cryptocurrencies.

That is not true. Bitcoin was launched in january 2009, which means it exists for the first time during a macro bear market. Previous crypto winters occurred amid the low interest rate environment, when all was well in the world.

Today, power outages are expected on cold nights in london this winter. Share prices of major technology companies have fallen by more than 70%. People are struggling to afford milk and bread. So no, crypto has never been there. Economically, these are dark times. And cryptocurrencies have never seen dark times before.

How to continue?

I'm not saying crypto won't do what it has always done – recover. I'm just saying that this is not the friendly crypto winter from the neighborhood, but a different animal altogether – driven by the macroeconomic bloodbath, with correlations rising accordingly.

Let me return to the first paragraph of this article when I said that bitcoin's growing correlation is both pessimistic and optimistic.

In the long run, bitcoin must decouple to achieve its "goal" of becoming a store of value; an exit from the government-controlled world of fiat money. It's hard to argue with that. And in that sense, the extremely high correlation that has risen so much this year is disappointing. Certainly bitcoin will have no hope in the long run unless it gives up this dirty habit of volatility and refusal to do anything without holding the hand of the stock market.

The reason I say it's also a bit bullish is that it shows bitcoin is now a mainstream financial asset. Over the past few years, there has been one bitcoin that has not correlated excessively with the market. It was a nerdy magic money thing on the internet, something your friend's older siblings told you at a barbecue party.

Liquidity was low and there was no impact on the financial market in general.

But now it is here. Acceptance has increased rapidly. In the media it is displayed next to the dow jones and gold when it comes to daily market movements. The correlation confirms this – it moves more than ever with the stock market.

The next step is the abolition of this correlation. And if you look at bitcoin's fundamentals, which are more like a commodity than a stock (the opposite of ethereum, by the way), it has what it takes to do this. The real question is whether people will recognize this and begin to value him as such.

And that is what makes it so fascinating as an investment class. We have never seen anything like it – a kind of commodity that lives in the digital world. For this reason, the range of outcomes is arguably wider than for any other asset.

Whatever happens, it's going to be a fun ride. But the numbers show that bitcoin is nothing more than a stock market toy being thrown around at will at the moment.

Invest in cryptocurrencies, stocks, etfs and more in minutes with our favorite broker, etoro erfahrungen

Like this post? Please share to your friends:
Leave a Reply

;-) :| :x :twisted: :smile: :shock: :sad: :roll: :razz: :oops: :o :mrgreen: :lol: :idea: :grin: :evil: :cry: :cool: :arrow: :???: :?: :!: