Bitcoin As A Stock Market Correction Hedge: What The Charts Reveal
Summary
- During the most recent stock market pullback, especially in tech, Bitcoin began to rise.
- This led to more talk of whether Bitcoin is an effective hedge against a severe sharp or sustained downturn in stocks.
- Analysts also speculated that Bitcoin is being used to hedge inflation.
- I tested data points from 2021 to see if it supports this theory and share the results below.
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Article Thesis
It has been much discussed whether cryptocurrency is an effective hedge against a stock market correction or crash. If it truly is a hedge against a sharp market downturn, it should generally experience a spike when the S&P 500 (SPY) and Nasdaq (QQQ) are spooked. I went back through 2021 to find data points for comparison and my results were interesting enough to be worth sharing.
JPM also recently remarked that Bitcoin (BTC-USD) could be replacing Gold (GLD) as the new inflation hedge. Inflation fears are real and justified. Supply chain woes are global and likely to continue to push prices higher. Wages are also rising as employers struggle to fill positions. This will also lead to higher prices. The FED may need to act sooner than it would like and begin raising rates. This is generally not positive for growth sector stocks.
The Data Points
The first item of business is to determine the data points for testing the theory. Luckily, there have been plenty of reasonably significant movements in 2021. I used the Nasdaq as the major control indicator as it has experienced more volatility than the S&P 500 and it is generally more susceptible to inflation-related downturns. This is due to the fear of rising rates and subsequent revaluation of these stocks by Wall Street. I note the points below on the graph.
Chart annotated by author.
Data Point #1. January 26th - January 29th
From January 26th, 2021 to January 29th, 2021 the Nasdaq dropped 4.27%. It began with a 2.79% drop on January 26th, recovery on the 27th, and deepening of the losses on the 28th.
During this time the GameStop (GME), and others, short squeezes were seen as culprits. GME stock rocketed to well over $300 over this same three-day period.
Some on Seeking Alpha predicted this would "Cripple the Stock Market", however this turned out to be slightly hyperbolic. While investors were very concerned that the market would have serious fundamental problems due to the short squeeze, did investors look to Bitcoin as a hedge? It appears so, as shown below.
Bitcoin gained sharply as the market was dipping. It then continued to gain consistently through mid-February even as the market recovered to new highs. Gold fell along with the market, although not as steeply.
Result: Affirmative evidence noted.
Data Point #2. February 15th - March 8th
From February 15th, 2021 to March 8th, 2021 the Nasdaq dropped over 10.8%. This is a technical correction. It did not reach new highs again until April 8th as shown below.
During this downturn in the Nasdaq, the DJIA (DIA) was reaching new highs. Treasury yields were surging.
"Equities often struggle when interest rates rise sharply, particularly when driven by real rates," Goldman Sachs equity strategist David Kostin wrote in a note Friday. "Stretched investor positioning has exacerbated the sharp recent equity market response, particularly because both hedge funds and retail investor have held large positions in long-duration equities that are particularly sensitive to interest rates."
This is a clear setup for Bitcoin to rise if it is being used as a hedge.
Once again, the above chart appears to support this theory. Note that gold fell along with the Nasdaq. On the longer chart, after the initial 10% correction, Bitcoin appears to generally mirror the broader market again.
Result: Affirmative evidence noted.
Data Point #3. April 26th - May 12th
From April 26th highs through May 12th, 2021 the Nasdaq fell over 7.2%. It did not recover to new highs until June 15th, 2021 as shown below.
What was going on during this time? Inflation worries were high according to Yahoo who notes: "Stocks rocked by inflation fears, Dow, Nasdaq, S&P tank..."
Once again, this is a setup for a sharp rise in a hedging instrument.
Once again, shown above, Bitcoin has gained significantly while the market stumbled. On the longer timeline, shown below, as the market once again made highs, Bitcoin was down which also supports this theory. However, it is critically important to note that the May drop in Bitcoin is likely much more related to the China cryptocurrency crackdown.
Result: Affirmative evidence noted.
Data Points #4 and #5. July 14th - Aug 23rd
I combined data points four and five as these are both fairly sudden declines in the midst of the same strong bullish trend. First, July 14th to July 19th, 2021 saw a drop of over 2.3% in the Nasdaq. This was followed by a strong recovery and then a quick nearly 2% dip and another recovery to new highs.
These downturns were largely attributed to a surge in COVID-19. Global markets were also down significantly and the DJIA slid over 700 points on July 19, 2021.
In this case, Bitcoin slid along with the major indexes. Gold was also down, although less so.
In the case of the August pullback, Bitcoin once again reacted similarly to the market.
Result: No affirmative evidence noted.
Data Point #6. September 6th - Oct 7th, 2021
After reaching more all-time highs on September 6th, the Nasdaq swooned over 7.5% through October 4th, 2021 as shown below.
This is a great data point as the downturn was sharp, fairly long in duration, and linked to both overexuberance and preparation for potential lasting inflation.
In this case, Bitcoin and Gold both fell along with the market, however much less than the red-hot tech stocks and moderately less than the DJIA, as shown below.
It did however drop much more than the indices prior to its October 4th recovery. Interestingly, the rise in Bitcoin on October 4th and subsequently was attributed to institutional demand by Reuters and on October 5th, the SEC noted it would not follow China and "ban" Bitcoin.
Result: Inconclusive.
Conclusion
The results seem to indicate what many have long suspected; that Bitcoin is loosely correlated to market sentiment but in fact its own asset class. It reacts to unique news and events including, but not limited to, those that affect stocks, bonds, and commodities. It is highly sensitive to news and rumor on regulations due to the nature of the asset class. Many, like JPM, try to fit it into a narrative: It is a market crash hedge, or perhaps an inflation hedge that will replace gold? However, as shown below, there is much more evidence needed that it will be a protection against actual inflation. As shown below, it seems to be following its own path.
The problem with narratives lies in their very appeal; simplicity.
The results of data testing are inconclusive, but nevertheless, interesting. As always, I recommend taking these prudent steps to prepare for a sudden market sell-off.
This article was written by
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.