Can Bitcoin rise if Tech Stocks don’t?
We have all heard that Bitcoin is correlated with ‘tech stocks’ (in this case, the Nasdaq 100 index), but what does this actually mean?
Simply put, a positive correlation means that the price movements of one asset closing track the price movements of another. In the case of Bitcoin, it is believed that it closely tracks the movements of technology stocks in the US. So much so that many investors seem to think that it is impossible for Bitcoin’s price to rise without the Nasdaq moving up too.
Let’s unpack this correlation, explain the importance and see whether Bitcoin can still have its crazy price rallies regardless of what the Nasdaq is doing.
Why does this correlation matter?
Correlation is a common tool for describing simple relationships without making a statement about cause and effect. A metric known as the correlation coefficient can tell you how strong or weak the relationship between two assets is.
The correlation coefficient can range between +1 and -1.
- +1 represents the strongest positive relationship
- At a +1 correlation, two assets move with the exact same magnitude and direction as each other — a perfect match.
- -1 represents the strongest negative relationship.
- At a -1 correlation, two assets move with the exact same magnitude but in the opposite direction to each other — a perfect inverse.
*When the correlation is at 0, there’s no observable relationship between the two assets.
As a savvy investor, I’m sure you understand how diversification (owning a basket of different investments) can help reduce the risk of your portfolio. A portfolio that is diversified by investing in assets with a zero or negative correlation to each other will have a lower probability of being affected by one negative investment event.
How strong is Bitcoin’s correlation to the Nasdaq?
Bitcoin’s correlation with the Nasdaq has been at a record high this year. As we can see from the chart below, the correlation has been getting stronger in the last three years, as Bitcoin has become a more well-known investment for institutional investors.
Why has this correlation strengthened in 2022?
Generally speaking, when markets experience steep declines, most assets tend to increase in their correlation to each other — and 2022 was no different.
Over time, people have realised that investing in Bitcoin is a bet on blockchain technology; and as such, Bitcoin has been treated similarly to technology stocks. This realisation has led to an increased correlation between Bitcoin and the technology sector at large.
So does this mean that Bitcoin will follow tech stocks forever?
The truth is, nobody knows, but many investment analysts worldwide believe that this correlation will not hold forever — let’s look at how inflation might affect this correlation.
Bitcoin: The inflation hedge
The idea that inflation hurts technology stocks has been well discussed in traditional finance over the years. The basic idea behind this is that when inflation increases, central banks will look to curb this inflation by increasing interest rates (something we are witnessing worldwide today). When interest rates rise, its effect on technology stocks is twofold:
- Higher interest rates reduce the profitability of technology stocks as many analysts will discount the company’s future earnings by this higher interest rate. Due to the nature of technology stocks and their earnings, you will find that most of their earnings come from revenues that are yet to be realised — they are far out in the future. This means that higher interest rates will have a dramatic effect on future earnings.
- Higher interest rates also increase debt payments for individuals. This increased cost ultimately reduces a consumer’s disposable income and, therefore, their ability to spend on products and services — this directly impacts the profits of businesses.
So how does Bitcoin hold up in a high inflation environment?
It’s believed that Bitcoin could be the new inflation hedge for the future. While gold has held this spotlight for many years, many are starting to see Bitcoin as a suitable replacement due to its similarities to the yellow metal.
One such similarity is their low inflation rate — a feature that is synonymous with assets that outperform in high inflation environments. Much like a gold miner pulls gold out of the ground and into existence, so too does a Bitcoin miner mine Bitcoins into existence. These similar mining processes mean that Bitcoin and gold produce closely related inflation rates (1.60% Bitcoin vs gold 2.00%).
Not only that, but Bitcoin goes one further by having a hard cap on its supply. This means that there will only ever be 21 million Bitcoins in existence — a feature that drives its value due to scarcity.
To this end, it is possible that Bitcoin starts to decouple from its correlation to technology stocks as interest rates continue to rise worldwide.
So, how does this affect me?
Throughout history, investors have looked to protect their wealth in times of uncertainty by investing in uncorrelated assets, thereby increasing their portfolio diversification.
Given the effects high-interest rates could have on technology stocks — there is a possibility Bitcoin’s correlation to this sector decreases, making it a powerful diversification tool in your portfolio.
The power of diversification has been used by world-renowned investors for years — so why shouldn’t you use it too?
How can I invest in Bitcoin?
You can seamlessly gain investment exposure to the highest-ranked crypto asset by exploring the Revix product suite. Start your financial journey in seconds with our easy sign-up process and low minimum investments.
Revix currently offers three ways to seamlessly invest in Bitcoin:
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- The Top 10 Bundle is like the JSE Top 40 or S&P 500 for crypto and provides equally weighted exposure to the top 10 crypto assets making up more than 75% of the crypto market. This way you get to own not only Bitcoin but the other 9 largest crypto assets for even further diversification.
The Inflation Shield is an algorithmically optimised investment basket, giving you the protection of gold with the performance of Bitcoin through a single investment. The ratio of gold to Bitcoin within the bundle is based on historic risk vs return data aimed at maximising returns while taking on the least amount of downside risk possible.
