Analysis Expert Blog

Is there an interrelation between stock market and bitcoin? Yes, but no

Watching the Bitcoin diagram, and that of the stock market, including the Dow Jones and the S&P 500, you may have noted an interesting likeness. The stock market was rising to new heights rapidly, with even Donald Trump tweeting how it had risen 20% since his election. Not long before these heights, Bitcoin had also risen to its all-time high of $20,000 on Dec. 17.

Both markets began dipping, first, it was Bitcoin, whose price immediately falled under $6,000 before hitting a floor. The stock market fell a lot faster, but the pattern looked notably similar, with them both finding a floor last Monday. The Dow Jones Industrial Average saw its largest 1-day point fall in history on Monday, and the S&P 500 had its worst day since 2011. Questions then started to spring up if there was an interrelation between completely different assets. And can we predict the further steps?

What happened to the stock?

In order to define whether there is an interrelation, one needs to address the causes why the stock market is down and investors are seemingly selling off. John F. Wasik, behavioral finance Forbes columnist names a number of causes why the Stocks have crashed. He thinks that the general stock market was overpriced, and uses a gauge by Robert Shiller, a Yale economics professor, to assess that. He adds that variability has returned, looking to the VIX index, and this is important in looking for the Bitcoin interrelation.

Apart from this, interest rates are growing and there is a belief that inflation may be on its way back. What happens next? In accordance with Jacob Kirkegaard, a senior fellow at the Peterson Institute for International Economics, the computers (which make 90% of transactions on the stock market) make their turn, calculating that even bigger inflation is unavoidable.

And why Bitcoin dropped?

These reasons as to why the stock market crashed are completely different to the causes why it was supposed that Bitcoin fell by almost 70%. The issue for Bitcoin, following an expected interrection once it hit $20,000, was that there was a flow of damaging media reports, some of them baseless and simply wrong.

Firstly, the embarrassment in S. Korea about a potential prohibition did its damage before it was finally cleared up by the S. Korean Government. Then, China declared it would be putting one more nail into Bitcoin’s coffin within the country by placing a firewall up to limit foreign access to exchanges. There was even news out of India that was terribly misunderstood, also regarding a potential prohibition, that saw Bitcoin fell.

From these external events, there is no perceptible relationship as to why the Bitcoin market and the Stock market fell at the same time. But looking deeper in terms of interrelation diagrams, you can see some type of link.

Z-scores and fear gauge

One zone of data which displays a interrelation is in a matrix of z-scores and p-scores. These correlation diagrams are pretty confusing, but the just of it is that if 2 assets share a z-score that is negative or positive, there is proof of either a direct or inverse relationship.

In the diagram below, the numbers are called z-scores. They represent the direction and power of the relationship between the 2 sets of data. A higher absolute z-score means greater correlation, while a lower absolute z-score means less of a correlation.

A simple view at this correlation diagram can proof that the relationship between Bitcoin and S&P 500 is at a weak positive relationship. But, the correlation between VIX and Bitcoin -0.31 making it a moderate negative relationship.

The VIX is a so-called “fear gauge” and defines the level of risk that is currently present in the markets at any time. In accordance with this diagram, there should be an inverse interrelation between VIX and Bitcoin, and this was showed in an article on CBOE’s website that overlayed the VIX and Bitcoin price. Thus, it is between the VIX and Bitcoin, not the Stock Market itself, where the correlation seems to exist. But then again, for the last 3 years, VIX Index outperformed Bitcoin in terms of variability and in 2015-2016 the correlation was almost non-existing, it’s 2017 that matches the pattern.

Fundstrat Tom Lee shared his agreement with this sentiment on CNBC saying that the original relationship between the Stock Graphs and the Bitcoin price had only bounded interrelation.

“[Bitcoin’s] could easily look like a chart that looks like the S&P, because both had a parabolic move and then subsequently gave back some of these gains,” Lee told CNBC’s “Trading Nation.”

However, that’s where the relationship may stagnate. Lee added that “the connection between the 2 is really, really limited.” He went on to discuss that the

interrelation, if any, may have been down to a more cavalier approach by investors who were also then purchasing cryptocurrency.

“In the past 12 months, not only did we have a strong rally in equities, we had a strong rally in cryptocurrencies. I wouldn’t be surprised if those investors who saw risk-on assets everywhere outperforming globally were also buying cryptocurrencies.”

Analysts at Datatrek added to Lee’s sentiment about this ‘crossover’ of investors. They said:

“Since investors have only one brain to process risk, they will make similar decisions about cryptocurrencies and stocks when they see price volatility in the latter.”

Correlation in the future?

C. Harvey, head of equity strategy at Wells Fargo, believes that perhaps there is a stronger correlation than has been stated formerly, but he, like Lee and Datatrek analysts, is linking these relationships more to sentiment that experiential evidence. “On Monday [February 5] what we saw is all risk products sell off,” Harvey said Wednesday on CNBC’s “Fast Money.” A hit on the market, in his opinion, can cause investors to panic and begin selling Bitcoin as well: “It sometimes adds fuel to the fire.”

Additionally, it is this idea that Bitcoin has crossed a threshold into the mainstream market too that could perhaps be causing this supposed interrelation. Harvey, and others, talk of similar sentiment meaning a similar sell off across the 2 markets. Morgan Stanley analysts have also claimed that perhaps traditional investors were transferring risk from the relatively stable equities markets into Bitcoin, and vice versa, showing again this crossover that could be amalgamating the markets faintly.

M. Poh, Trading Trainee at Octagon Strategy, also believes that the 2 markets are starting to intermingle somewhat as he says:

“As for it being indirectly related, I would say that BTC is considered to many as a hedge against currencies, similar to that of gold. Therefore, if the demand, recognition and acceptance of BTC becomes much larger, there is a chance it would be in a similar position to that of gold and the stock market.”

Fear breeds fear

It is possible that the idea of correlation between the Bitcoin market and that of traditional stocks is limited to the “fear index” because of cryptocurrency hum in 2017 and the bull rally of investors. They cannot truly be plotted on a graph against one another, and have often deviated at key moments. For instance, In August last year, the global economy took a huge hit in the face of growing tensions between the USA and N. Korea, but the Bitcoin market remained unperturbed.

But what is the conclusin from this recent pattern across the markets is that investor sentiment can carry over from the stock market to the Bitcoin market. Because of a mainstream adoption wave that has seen Bitcoin accepted as an investable asset, there is the beginning of a crossover.

So, when fear and risk enters the stock market for causes outlines by John Wasik then the VIX also starts to grow. It has been shown that there is an back interrelation between this and the price of Bitcoin which can be seen on an overlapping diagram. None of these relationships or correlations, tenuous as they are, can really help with predicting the markets, they can only prove that investment fear is not just isolated to the stocks. As for now, Tom Lee sums it up in a bold, no nonsense manner:

“Cryptocurrencies have their own economy based on activity on that Blockchain. Equities have their own economy based on earnings per share multiples. The institutional overlap is essentially zero.”