Perhaps the most popular word in the financial world is diversification. The idea is that investors should hold multiple eggs in multiple baskets. It’s as simple as that.
The problem that has arisen recently is that many of the diversification strategies investors used didn’t work during stock market collapses. Even stocks that were supposed to be true diversifiers performed similarly. For example, consumer staples and construction – widely different industries – in general moved together most of the time.
One question to consider is this: Is Bitcoin is a good tool for diversification? Let’s take a look.
Bitcoin and the S&P 500
Here’s a look at the performance of the Coinbase cryptocurrency index (which is made up of 75% Bitcoin) and the S&P 500.
In green is the S&P 500 (right axis). In beautiful pink is the Coinbase Index (left axis). See any real strong correlation? It’s difficult to tell from this broad level view. A little bit of econometrics may be helpful.
The Daily Movements
Before doing some correlation statistics, let’s look at the day over day movements for the two financial indexes. As with the previous graph, the pink line is the 14-day moving average of the day-over-day Coinbase Index (left axis). The green line represents the same things for the S&P 500 (right axis).
Interestingly, the two appear only somewhat positively connected. Positively connected means they move in the same direction – when the price of one goes up, the price of the other also generally goes up. For a fairly significant amount of the time, the two are negatively correlated, meaning that when one goes up, the other generally goes down (and vice versa).
The inconsistency in the relationship suggests that Bitcoin and other cryptocurrencies may be useful diversification tools in a financial portfolio.
The two previous graphs are, of course, just graphical exploration tools. Here’s a more detailed look at the numerical correlation.
The figure shows the correlation between the day-over-day changes in the Coinbase Index and the S&P 500. The blue are periods when the correlation was positive (again, when one goes up, so does the other usually). In orange are periods when the correlation was negative (again, when one goes up, the other generally goes down).
Interestingly, there’s a good amount of inconsistency, which suggests Bitcoin may be a good addition to a diversified portfolio.
In looking at the relationship between Bitcoin and other cryptocurrencies and the performance of stock markets appears to be more unrelated than related. This is good news for investors looking to diversify a financial portfolio. Perhaps it is time to consider Bitcoin as an important component in portfolio construction.