As the investing world waited over the last month or so for the US Federal Reserve to lower interest rates the stock market rallied and so did cryptocurrencies. In fact, the two moved nearly in lockstep similar to when they fell together during crypto winter and rose again a year or so later. Considering that cryptocurrencies were supposed to be an asset class separate from the traditional financial system, what does the crypto correlation with stocks mean?
How Does Crypto Correlate With the Stock Market?
A recent Bloomberg article noted that crypto’s correlation with US stocks was nearing its highest correlation ever. The correlation simply means that prices move up and down more or less in tandem but it does not provide an explanation for why this happens. The price correlation between cryptocurrencies and the US stock market is not constant. In fact, over the years the correlation has moved from positive to negative and back again and done this many times. A negative correlation means that when one goes up the other goes down unlike a positive correlation like recently when stocks and crypto rose up together.
Graph of Crypto to Stock Correlation Courtesy of Bloomberg
Crypto and Stocks As Investments Versus Speculative Assets
Prices in the stock market are driven by two general factors. Over the long run a stock’s price goes up or down based on the fundamentals of the company that issued the stock. Is it making money and how much? And is it likely to keep making money into the future? In conjunction with this, is the current stock price reasonable in regard to the stock’s near and longer-term prospects. We have referred to this issue, intrinsic stock value, frequently in our writing. For folks who are putting money into Bitcoin, Ether or or other cryptocurrencies for the long haul, the issue is pretty much the same. What will the asset be worth five, ten, or twenty years from now and does the current price reflect the likely eventual price? This is the world of investing as opposed to short term speculation.
Speculation in Stocks Versus Cryptocurrencies
Although Bitcoin, the first cryptocurrency and the still dominant one, was invented to simply be a means of exchange via the internet it became an investable and especially a tradable asset over the years. Bitcoin has been famous for being very volatile with huge price swings. Thus, like with most volatile assets, there are often greater profits to be made by buying and then selling at the just right times than by buying and holding. The folks who bought Bitcoin very early and held on are very rich. Folks who have purchased more recently have not always done so well. When we look at Bitcoin speculation of late we see similarities to speculation in the stock market where very often traders can make more money than long term investors.
What Factors Are Driving Crypto and Stock Prices?
The most recent runups in both crypto and stock markets have had to do with expectations of an interest rate cut by the US Federal Reserve. This is a so-called macroeconomic factor. As a rule folks buy riskier assets when interest rates are lower than when they are higher. This tends to drive prices up and in this case, it has driven up both stocks and crypto. One factor that one might expect to make a difference is the presence of ETFs that track the spot prices of Bitcoin and Ether as these were not present a year ago. However, for both of these cryptocurrencies the amount of trading that ETFs are responsible for is only a small fraction of all trading of these tokens.
What appears to be happening is that when a major macroeconomic issue emerges traders in both the crypto and stock markets are making there trades based on current market sentiment as it relates to that issue. Long term investment viability is not so much the issue as is placing trades for short term gains.