Bitcoin Remains an Uncorrelated Asset with Idiosyncratic Risk, Says Crypto Trader
In 2020, what we have been seeing is Bitcoin following the equities market and its correlation with the stock market surging to a new high.
Currently, Bitcoin is trading above $7,000, after a strong move yesterday. The next move in BTC “would depend on what stock indices do. Bitcoin continues to trade like a risk-on asset. Rolling correlations between BTC and the S&P 500 remain around historical highs,” said economist and trader Alex Kruger.
Binance’s latest report also says that despite BTC's price down by 10% and S&P 500 by over 19% in 1Q20, BTC displayed a moderate positive correlation with US equity indexes of 0.57 but is very unlikely to persist in the medium to long term.
However, trader Scott Melker says Bitcoin and stocks having similar price movements at times over the past weeks doesn’t mean they are correlated assets.
Historically, No Correlation
Melker took to Twitter to explain how the idea of ranking correlated assets was developed by Markowitz using a math formula, one can compare two assets on a scale to -1 to 1. Here, 1 is correlated if an asset moves a particular percentage on a given day so will the other asset, while -1 means inversely correlated and 0 not correlated.
Now, when it comes to bitcoin in its 11-year history, its correlation with stocks has been .15, which is not correlated. Then in March, it hit .57, moderately correlated for a brief time.
“The problem with Modern Portfolio Theory is that everything moves nearly to a 1 in a global crisis – including other “safe haven” assets like gold and silver. And Bitcoin STILL only reached a .57 – moderate correlation. This is math & defines correlation,” Melker said.
He further pointed out how while bitcoin bottomed on March 12th, SPX didn’t bottom until 10 days after that on 23rd. During this gap, the price of bitcoin was rising higher, surging 84% while SPX continued to fall.
Now, “to believe they are correlated directly would mean that Bitcoin was leading the market,” which isn’t the case.
This is why all investors should hold some Bitcoin
Ever since bottoming out, both bitcoin and SPX have leveled out and had “somewhat similar price movement” while BTC still led on low time frames.
As a matter of fact, four assets in the legacy markets; stocks, bonds, commodities, and currencies, all are correlated to various degrees. The thing is, all of these assets are valued based on similar factors like interest rates, GDP, and corporate earnings.
Bitcoin, on the other hand, finds value from millennial adoption, government regulation, network value, and other completely separate factors shared Mark Yusko, founder, and CEO Morgan Creek Capital Management.
As such, by definition Bitcoin, which is a hedge against hyperinflation and bad actors is uncorrelated to equity markets.
“This is the very reason that all investors should hold some Bitcoin – it offers idiosyncratic risk rather than systematic risk like other assets. Even if it is a RISKIER asset, having it in a portfolio reduces overall portfolio risk due to this lack of correlation,” said Melker.