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Bitcoin’s correlation with the stock market

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Anyone who follows me will know that I like to take a macro view of Bitcoin. It is now firmly entrenched as an asset class on the big stage, which means it is subject to the whims of the broader market, for better or worse.

I often say it’s the tail of the dog, the dog being the stock market. But I wanted to put together an article detailing the exact relationship between Bitcoin and stock market movements this year, to test that theory.

The first step was, of course, correlation. Below, I plotted the correlation between the stock market and Bitcoin since Russia invaded Ukraine in February (my metric of choice was Pearson for 3 consecutive months).

         
    

It is obvious to see that this spiked around April. Incidentally, that is when we moved to a new interest rate paradigm. Inflation got so bad that it could no longer be held in check, and the Fed was forced to start raising rates, ending the era of free money. Let me overlay the Fed rate on the same chart:

         
    

So this correlation spike around April makes sense. As we move into a new environment, cheap money and quantitative easing are disappearing and risk assets are suffering the consequences. The old adage goes that “correlations go to 1 in a crisis.” And with this massive downward move in interest rates, risk assets have sold off like there is no tomorrow, and the correlation has risen accordingly, to as close to 1 as possible.

So why did the correlation drop from this near-perfect score of 1 to 0.5 in August?

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Well, my theory is this: let’s not forget the great violence in the cryptocurrency market that took place over the summer, when markets melted down and capital fled faster than a British prime minister. Luna, one of the top 10 coins, disappeared into thin air, taking billions of dollars with it.

Then, in August, while the cryptocurrency was still in shock, the stock market rebounded. But with the pain the cryptocurrency had just endured, investors were reluctant to bid prices back up, as they worried about systemic defaults and other events that could trigger another sea of cascading liquidations. Make no mistake: the Terra contagion was an idiosyncratic event for cryptocurrencies and greatly shook confidence in the space.

Let me overlay the S&P 500 to show it rising in August, while bitcoin politely refused to follow:

         
    

Then, as you can see from the chart, starting in September, the stock market starts to fall again, and the Bitcoin decides to follow again. The fear in the cryptocurrency markets this year is almost unprecedented – and these charts above show it more than ever.

Bitcoin got the upper hand on the stock market, until things started to pick up in August, when the Bitcoin wasn’t ready to let the good times roll again.

So currently we are back to correlations around 0.8, an incredibly high number. I’m afraid I sound like a broken record, but anyone extrapolating information from past cryptocurrency market cycles is completely wrong, and I think these charts show why.

We’ve had a structural disruption and it’s a whole new paradigm. Surprisingly, money costs something now, when interest rates are no longer zero. Driving to the store is a luxury, whereas this weekend I paid £8 for a pint. £8! Inflation is here, as are high interest rates, and that’s a nasty cocktail for all risk assets.

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But for bitcoin, you’ve never seen any of this before. It has never existed in a bear market before: it was launched in 2009, just as the stock market was experiencing one of the longest and most explosive bull runs in history.

But no more. Bitcoin is now in the trenches, with inflation spiraling, interest rates rising and the geopolitical climate deteriorating by the day. It’s not a good time for anything that lives far on the risk spectrum, and that’s evidenced by Bitcoin’s price action this year.

So, in closing, keep an eye on the stock market. If it falls, it will continue to take bitcoin with it.

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