Might the volatile prices of bitcoin and other cryptocurrencies indicate shifts in investor sentiment ahead of moves in the stock market? Yes, say some investment professionals, including two chief investment officers (CIOs), as quoted by The Wall Street Journal. Doug Ramsey of The Leuthold Group, a firm that provides financial research to institutional investors, told the Journal, “We’ve begun to watch bitcoin more closely as a sign of speculative enthusiasm.” Tom Forester, of Forester Capital Management concurs. “We do view bitcoin as a sentiment indicator,” he remarked to the WSJ.
When Sentiment Trumps Fundamentals
Analysis by DataTrek Research suggests the correlation between bitcoin and stocks is at its highest when sentiment, rather than fundamentals, is the primary driver of moves in the financial markets, the Journal says. During the stock market correction earlier this year, that correlation hit an all-time peak, per both sources. But Nicholas Colas, the co-founder of DataTrek, told the WSJ that the correlation is strongest when both bitcoin and stocks are falling. As a result, he noted, the correlation has weakened since the recent stock market correction ended. (For related reading, see also: More Evidence That Cryptocurrencies Are a Bubble?)
Loss of Risk Appetite
When risk-loving investors lose their appetite for the highest-returning, most volatile, most speculative assets, a more generalized downturn in asset values often follows, the Journal observes. Today, cryptocurrencies may be playing a role that older asset classes played in previous frothy markets, the Journal theorizes. When the Dotcom Bubble burst, for example, the most speculative internet startups with the thinnest histories of profits were among the earliest and the hardest to fall, the WSJ adds. As measured by the Investopedia Anxiety Index (IAI), our millions of readers worldwide remain very concerned about the securities markets.
Recent Price Moves
The S&P 500 Index (SPX) fell by 10.2% during the correction between its record high close on January 26 and its recent low close on February 8. During this same period, the price of bitcoin declined by 25.7%, and it tumbled by 64.3% from its all-time high on December 16 to its recent low on February 5, per CoinDesk. As of February 5, its low so far in 2018, bitcoin was down by 51.1% YTD.
For the year-to-date through 5:25 PM New York time on March 12, bitcoin was down by 35.3%, after rocketing up by 1,289% in 2017. The respective figures for the S&P 500 are gains of 4.1% YTD and 19.4% in 2017.
To be sure, using bitcoin as a leading indicator of stock prices is still a very controversial topic. Jason Ware, CIO of the Albion Financial Group, was scathing in his comments to the Journal: “I think that’s absurd. Ultimately, stock returns are grounded in the economy, corporate earnings, interest rates and inflation.” He also noted, per the Journal, that investors in bitcoin typically pay little or no attention to these fundamentals.
Correlation vs. Causation
Apropos Ware’s comments, the Journal points out that apparent correlations between the prices of bitcoin and stocks are not necessarily the result of similar, let alone the same, causative factors. For example, the most selloff in stock prices was spurred, in the opinion of most analysts, by President Trump’s March 1 announcement of steep tariffs on imported steel and aluminum. At roughly the same time, the prospect of cryptocurrencies being banned in some countries or subject to regulation in others was growing. (For more, see also: Bloodbath in Crypto Markets and Bitcoin Price on Fears of Government Crackdown.)
Investing in cryptocurrencies and other Initial Coin Offerings (“ICOs”) is highly risky and speculative, and this article is not a recommendation by Investopedia or the writer to invest in cryptocurrencies or other ICOs. Since each individual’s situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein. As of the date this article was written, the author does not own any cryptocurrencies and does not own any cyrptocurrency-related company shares.