The correlation between Bitcoin and the stock market recently dropped to near zero. This occurred as Bitcoin's value increased along with gold, while stock prices declined due to the conflict in the Middle East. Could this be a new normal?
October marked the second occasion this year (following the March banking crisis) when Bitcoin demonstrated its potential as a defensive asset, appreciating in value alongside gold amidst pressures on stocks arising from the Middle East conflict.
Bitcoin (yellow), gold (green) and S&P 500 (white)
More generally, Bitcoin is becoming increasingly independent of the stock market, with their correlation showing a steady decline this year, recently falling to zero
Bitcoin correlation with stock indexes
A formal correlation analysis conducted using the Bloomberg Beta Calculator—which employs the least squares method and can also be replicated in Excel—indicates a negligible correlation between Bitcoin and the stock market over the past year, as evidenced by an R-squared (R^2) value of just 0.129. For those who may need a refresher on statistical terms, Wikipedia elucidates that the 'coefficient of determination, represented as R^2, quantifies the proportion of variance in the dependent variable that can be predicted from the independent variable(s).' Essentially, it measures the extent to which the model can replicate observed outcomes by explaining the variation in outcomes.
According to conventional interpretations, an R^2 value below 0.3 typically suggests a lack of correlation. Values ranging from 0.3 to 0.5 indicate a weak correlation, those from 0.5 to 0.7 suggest a moderate correlation, and values above 0.7 are indicative of a strong correlation. It’s also important to note that applying the least squares method, particularly to time series data, comes with numerous caveats that must be considered in the analysis.
1-year Bitcoin beta to S&P 500
A year ago, the same calculator showed a weak but significant correlation between Bitcoin and the S&P 500 index over a 1-year time interval.
1 year ago, 1-year Bitcoin beta to S&P 500
Over a longer term, the correlation observed last year appears to be an anomaly when considering the past five years as a whole; during this extended period, there has been no correlation between Bitcoin and the S&P 500 index. This lack of correlation could, in my opinion, be attributed to Bitcoin's relatively small market capitalization prior to its rally during the pandemic. Before October 2020, Bitcoin's market cap was 3 to 6 times smaller than it is today, classifying it as more of a niche asset. In contrast, the stock market capitalization exhibits far less volatility. Given that Bitcoin is an evolving asset, its past performance may not be entirely indicative of its future behavior. A longer-term analysis could be somewhat misleading, as the asset has undergone significant changes in recent years.
5-year Bitcoin beta to S&P 500
As I discussed in the aftermath of the March banking crisis, Bitcoin demonstrated a remarkable decoupling from most other risk assets during that time, mirroring the behavior of gold. This shift severed the prior correlations that linked Bitcoin and the broader cryptocurrency market with high-risk technology stocks, as exemplified by the ARK Innovation ETF (ARKK). This pattern was observed again in October amidst the onset of the Middle East conflict. It is indeed promising to see Bitcoin increasingly behave like a nascent safe-haven asset, yet it is prudent to consider alternative explanations for this emerging dynamic.
Firstly, this year has seen the S&P 500 exhibit a lower correlation with most assets, not solely Bitcoin. In 2022, the dominant macroeconomic trend of rising interest rates led to a general decline across most asset classes, thereby enhancing correlations. However, in the current year, despite the continuation of rate hikes that suppressed many assets, the S&P 500 has remained resilient, buoyed by a stronger-than-expected U.S. economy and the surge in interest surrounding artificial intelligence. This perspective seems logical at first glance, but a meticulous analysis reveals that the S&P 500's divergence is not reflected in daily movements, which are critical for calculating betas.
To illustrate this point, I applied the Bloomberg beta calculator to assess the correlation between gold and emerging market stocks with the S&P 500, analyzing both the past year and the year prior. For both assets, the R-squared (R^2) values showed no substantial change. Gold maintained a near-zero correlation with the S&P 500 in both periods, with the R^2 values being nearly identical.
1-year SPDR Gold Shares ETF beta to S&P 500
1 year ago, 1-year SPDR Gold Shares ETF beta to S&P 500
Emerging market stocks exhibit a weak correlation with the S&P 500 across both time intervals, with only a marginal change in the R-squared (R^2) values between the two periods.
1-year iShares MSCI Emerging Markets ETF beta to S&P 500
1 year ago, 1-year iShares MSCI Emerging Markets ETF beta to S&P 500
A second theory posits that Bitcoin may simply be leading the stock market, reacting more swiftly than the S&P 500 to shifts in the bond market. Notably in October, the 10-year Treasury yield failed to break above the 5% threshold, hinting at a potential peak and subsequent reversal. Bitcoin has historically shown a high sensitivity to yield fluctuations, particularly to real yields. Should Bitcoin be ahead of the curve in responding to the bond market, this might imply that the observed low correlation with the S&P 500 is not a fundamental change but rather a temporary divergence.
US Treasuries 10-year yield (%)
Nonetheless, the current trends seem to indicate a shift towards a new correlation regime. In October, Bitcoin reached a new year-to-date high, and gold almost returned to its year-to-date peak, despite the presence of much higher long-term real interest rates. This deviates from the historical pattern where both Bitcoin and gold typically benefited from lower long-term real rates and were adversely impacted by higher ones. This suggests a possible genuine shift in correlations, perhaps reflecting a trend of diversification towards independent assets like gold and Bitcoin, away from traditional Western markets.
Bitcoin's trading behavior is increasingly reminiscent of gold, spiking during times of crisis and showing a diminishing correlation with the stock market. This is a departure from the previous year, as Bitcoin now displays no correlation with the S&P 500 index. This lack of correlation is noteworthy, especially considering that the correlation of other assets to the S&P 500 has not experienced the same change this year (based on the daily movements used to calculate betas).
The emergence of Bitcoin as a potential new safe haven asset is promising. In my opinion, there's a possibility that Bitcoin could evolve to become 'digital gold.' Perhaps this year we are witnessing Bitcoin transitioning to trade like an at-the-money option, a significant change from its prior status as an out-of-the-money option.
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