We often highlight the correlations between bitcoin and the Nasdaq as well as other assets. But what about this correlation? Is it still as relevant since for several months we have lost this correlation? This is where we will highlight the different elements that allow us to better understand the periods of correlation where these are present or absent.
What does the principle of correlation mean?
Before you begin, you need to understand the principle of correlation. This highlights the strength between two assets. When two assets are positively correlated, this means that they will vary in the same direction depending on the degree of correlation. If we assume that Nasdaq and bitcoin have a strong correlation, this means that if Nasdaq goes up, bitcoin should go up too. From a technical point, when we talk about correlation, we are going to put forward a way of measuring it. These measurements are made on a scale of -1 to +1.
- Above 0.5 or below -0.5 means it is a strong positive or negative correlation
- Between 0.3 and 0.5 or -0.3/-0.5, it is a moderate positive or negative correlation
- The closer we get to 1 or -1, the greater the correlation.
- Between 0.1 and 0.3 or -0.1-/-0.3, this results in a fragile correlation
When these units of measurement are positive, it means that there is a positive correlation, they should vary in the same direction. And when they are negative, this means that they will vary in the opposite direction.
The Benefits of Using Correlations
When you want to diversify a portfolio via major asset classes such as:
- the actions,
- the obligations,
- raw materials,
- currencies or
Portfolio managers will tend to use correlations to reduce risk. Therefore, managers will want to use assets that have negative correlations in order to reduce risk exposure from certain assets and smooth out fluctuations in the overall portfolio. Here is a table highlighting the correlations between the different types of assets:
You should know that these figures can vary depending on the period over which the data is taken since the context changes. The more we want to diversify a portfolio, the more we will use negative correlations. In a deflationary environment, stocks and bonds will have negative correlations. They will vary in opposite directions. This is why during a recession, bonds will outperform stocks. This is also why bonds play a protective role during a recession:
The particularities of Bitcoin vs Nasdaq
Even if the correlation is positive between the two assets, there are periods where this correlation decreases, that is to say we have periods where they will not necessarily evolve in the same direction. We notice that this decorrelation becomes more pronounced when we are in a period of economic slowdown. As the Nasdaq is made up of several companies, we can see that it has strong resilience at the end of the economic cycle. A resilience which can be reflected in the resilience of certain companies (mega caps) with a significant weighting within the index. The Nasdaq will vary according to:
- The growth
- The micro part such as income, profits, competitiveness, ability to repay debts…
- Monetary policy
- Tax policy
Bitcoin is an asset in its own right, it will vary depending on different factors, some of which will be similar to the variation of bitcoin. Here is a list of items like:
- The growth
- The US dollar
- The halving
- An accommodating monetary policy
- External catalyst (good or bad news)
Correlations between bitcoin and Nasdaq
Basically, bitcoin and Nasdaq are two completely different assets. One represents a currency and the other several growth companies, particularly technological. The common point they may have is the technological side since bitcoin popularized the blockchain system. Bitcoin is considered a risky and volatile asset. The Nasdaq is just as volatile. Here is a correlation table between bitcoin and other assets. In the short term, there are periods of detachment between the two assets, i.e. the correlation decreases.
But in the long term, we can see a fairly strong correlation between the two assets between 0.5 and 1. We will subsequently see the periods where this strong correlation is more probable.
It is better to compare assets which have a strong correlation close to 0.5/8, there is a greater probability of maintaining the strength of the relationship between the two assets over the long term and in different contexts.
Correlation and growth cycle
As we can see in the graph above, there are periods where the two assets are correlated and others where they are not correlated. Everything will depend on the environment. In a favorable context which results in an acceleration of growth, the two assets will be strongly correlated. This is often a time when financial conditions are more accommodating. You can see this in the chart below between 2020 and 2022 when we were in a growth acceleration cycle. This cycle has resulted in low rates and liquidity injections.
And during downturns, that’s usually where we have a bear market. The indices can also be affected and have more difficulties, but there can be gaps since in an index, there are companies which are more resilient like AAPL, MSFT, GOOG and which hold a lot of cash.
The institutionalization of bitcoin
We know that institutions are increasingly involved in the democratization of bitcoin. They already offer ETFs (on futures or futures contracts), futures, options on futures… This also implies a bitcoin which is less volatile than in its infancy since there are more participants. On the other hand, institutionalization offers several possibilities for arbitrage and manipulation just like in traditional markets.
The most anticipated change in terms of institutionalization will be the arrival of SPOT ETFs which will truly follow the variation of bitcoin. Currently, institutions offer ETFs on bitcoin futures, which implies that the ETF is linked to the futures contract and not the bitcoin directly. A spot ETF will change everything since institutions will have to buy bitcoin to offer this type of ETF. The more participants there are within the industry, the more it will help with democratization, which will result in increasing demand. And the greater the demand, the more bitcoin will attract institutions. Consequently, this can even become contradictory to the usefulness of bitcoin since it was created as a counter-offensive to the decisions of institutions, in particular central banks.
The impact of institutionalization in asset correlation
The transition towards the institutionalization of bitcoin should increase the correlation with the indices. As long as the correlation level remains positive, operators will have to act accordingly on asset allocation to minimize risk. This means they cannot allocate a large allocation to bitcoin if they already have exposure to Nasdaq. And since bitcoin is more volatile than Nasdaq, the allocation should be smaller than Nasdaq. . That said, as bitcoin is considered an asset that outperforms when financial conditions are favorable much like the Nasdaq, this should maintain the correlation between the two assets.
The detachment of bitcoin
In my opinion, for bitcoin to stand out from other “risk on” assets and in particular from Nasdaq, a major element would have to change in the current environment. Something that is not yet current. As bitcoin was created at the same time as money printing in 2009, perhaps the consequences of money printing could bring bitcoin back into use. For example, a hyperinflation phenomenon could cause bitcoin to become detached from other assets. Hyperinflation manifests itself by a rapid and high rise in prices, to the point that it becomes uncontrollable and endangers the local currency. So far, we have still escaped it. The latest money printing has led to inflation, but not hyperinflation. This kind of environment would really be very unfavorable for the economy. This is the case in Argentina for example, we can see the strength of bitcoin against the local currency.
It must be understood that there are periods when the correlation between the two assets is significant, particularly when financial conditions are accommodating. The rest of the time, there may be a temporary decorrelation since they are not constituted in the same way. Institutionalization should detach bitcoin from its main function for a time and accentuate its correlation to indices, but a catch-up on its usefulness could return in the event of a catalytic phenomenon such as hyperinflation.
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