Can Bitcoin Rise If The Nasdaq Doesn’t?

Can Bitcoin Rise If The Nasdaq Doesn’t?
Jonathan Hobbs

over 1 year ago4 mins

  • Bitcoin and the Nasdaq have been highly correlated this year, but that hasn’t always been the case.

  • The correlation coefficient measures the correlation between two investments, and ranges from +1 (where they’re making the same moves in the same directions) to -1 (where two assets move in the exact opposite directions).

  • Bitcoin might begin to perform differently from the Nasdaq if inflation gets a lot higher, or if the economy takes a turn for the worse. And since Bitcoin is much smaller than the market for growth stocks, a few big traders could easily shift its direction, pulling it away from its Nasdaq bond.

Bitcoin and the Nasdaq have been highly correlated this year, but that hasn’t always been the case.

The correlation coefficient measures the correlation between two investments, and ranges from +1 (where they’re making the same moves in the same directions) to -1 (where two assets move in the exact opposite directions).

Bitcoin might begin to perform differently from the Nasdaq if inflation gets a lot higher, or if the economy takes a turn for the worse. And since Bitcoin is much smaller than the market for growth stocks, a few big traders could easily shift its direction, pulling it away from its Nasdaq bond.

Bitcoin and the market’s so-called growth stocks have been moving almost in lockstep this year. So much so, that most investors now believe that bitcoin can only go up if the Nasdaq 100 (which is heavy with tech-sector growth stocks) does the same. But the data suggests the two are not as tightly correlated as you might think.

What’s the big deal about correlations?

Two investments are said to be correlated if they are moving up and down in tandem, and the “correlation coefficient” can help you find out exactly how strong that relationship is. Correlation coefficients can range between +1 (when two assets are moving by the same percentage in the same direction) and -1 (when they’re moving exactly opposite). When the coefficient is at zero, that means there’s no relationship at all.

As I’m sure you understand, diversification – owning a basket of different investments – can help stabilize your portfolio. That makes sense: if one or two of your investments are going up while the rest are going down, you’ll be better protected from large drops in your portfolio. And the less correlated your investments are, the better that all works out.

How correlated is bitcoin with the Nasdaq, exactly?

This year, bitcoin’s correlation with the Nasdaq has been at record highs. Using an Excel spreadsheet, I worked out the correlation coefficients between their weekly returns for each year since 2015 (blue bars), as well as the overall correlation from 2015 until now (gray dotted line). You can see that the correlation has been going up over the past three years, and it’s now way above its longer-term average of 0.2.

Correlation coefficients of bitcoin with Nasdaq per year (blue bars) and over the whole time (gray dotted line). Calculated using weekly prices from Yahoo Finance.
Correlation coefficients of bitcoin with Nasdaq per year (blue bars) and over the whole time (gray dotted line). Calculated using weekly prices from Yahoo Finance.

Why has bitcoin’s correlation with the Nasdaq gone up so much this year?

There are two reasons for this. First, there’s an old saying in investing: in times of crisis, all correlations go to 1. When investors are worried about the markets – as many are right now – they don’t discriminate when they hit the sell button. And the effect compounds as overleveraged traders are forced to sell out of their more volatile investments as prices plunge lower.

Second, markets are driven by popular narratives. And the narrative that bitcoin – like growth stocks – is a “risk asset” has become a lot more popular among mainstream investors this year. If you think of bitcoin as a new technology with big growth potential, that does make sense. Risk assets usually do better when investors have more confidence in the market and the economy. That leads them to take bigger bets for bigger returns, rather than play it safe by trying to preserve the value of their wealth at all costs.

So does that mean this strong correlation is going to hold?

Not necessarily. There are two possible economic scenarios that could break bitcoin’s bond with the Nasdaq.

The first scenario happens if inflation rips higher than everyone expects, and stays there for longer. See, investors buy growth stocks because they expect those companies to earn most of their profits further into the future. But if inflation is really high, they’d perceive today’s value of those profits to be much lower, so they’d be less willing to buy growth stocks.

Spiraling-higher inflation would also force the Federal Reserve (the Fed) to hike interest rates even more aggressively, which would hurt growth stocks even more. That’s because analysts work out the current value of a stock by discounting the future value of its earnings using a “discount rate”. If interest rates go up, so does that discount rate, which brings down the stock’s current value.

Bitcoin, on the other hand, could do very well if inflation balloons: there’s a finite coin supply, after all, and the narrative could quickly shift if investors see the value of traditional currencies eroding more and more each month.

The second scenario happens if economic growth collapses more than expected and drags inflation to the floor with it. The Fed would then be forced to shift gears and lower interest rates, stimulating the economy in a bid to keep people employed. This scenario might also lead the central bank to expand the money supply by buying more government bonds. And while that might give growth stocks a bit of a boost, I think it would be rocket fuel for bitcoin. Bitcoin might not have proven itself as a hedge against inflation just yet, but it’s certainly shown us what it can do when central banks “print more money” with bond-buying programs.

Consider too that bitcoin has a much smaller market size than the market for US growth stocks. Bitcoin is valued at just $400 billion, while the total market size of all the stocks in the Nasdaq is around $20 trillion. That means it takes a lot less fire power to move the price of bitcoin (up or down) than it does to move the Nasdaq. So if bigger buyers start scooping up bitcoin for whatever reason, it could quickly break away from the growth stock index.

What’s the opportunity then?

Regardless of what happens to the economy, it’s important to remember that correlations shift constantly. So it makes sense to own growth stocks and bitcoin, rather than owning one or the other. And even if the correlation stays where it is, there are still diversification benefits to owning both.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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