Main Thesis / Background
The purpose of this article is to discuss the popular alternative option of Bitcoin (BTC-USD), which is the preferred cryptocurrency of many retail investors. I was a skeptic at first myself, but I eventually took the plunge in 2021. Since then, I have followed BTC’s price action closely, and have taken a more vested interest in the crypto-world as a whole. With 2022 underway, and with quite a bit of volatility already behind us, I wanted to take another look at this small part of my portfolio to see if I should make any adjustments and/or change my outlook.
Looking back, there was quite a bit to be excited about, for a time. BTC soared, along with many risk-on assets in 2021. Back in August, the coin was trading just under $41,000, which quickly leaped higher (clocking in gains over 50% at one point). Yet, the thrill of the investment has waned with time. Further, as risk-off became a theme in 2022, coupled with the prospect of higher interest rates, we see BTC trading at almost identical levels. (The first graphic is BTC’s price during my 8/21 review, the second graphic is current):
Granted this “back to even” performance does not really reflect the full story. BTC had seen a tremendously positive move, upwards of $60,000, in the interim. For investors who took some profit there, and generally bought only on weakness in the past twelve months, they are probably doing pretty well. But for the buy-and-hold types, this result has got to be disappointing.
For me, I viewed this as a perfect opportunity to reflect on my position and see if I should add to it. After all, I liked it in the low and mid-40s before, so why not now? While I do see some merit to adding to my position here, there are some macro forces at play that ultimately make me reluctant. As a result, my outlook is a bit more cautious or neutral than it was a year ago, despite the price being roughly the same. This tells me to keep on holding what I got, but to wait for a better opportunity to present itself before adding more.
Correlation With Stocks Rising
My first thought is to discuss the rising correlation between crypto and the S&P 500. This is of varying importance to investors – some might care, some might not. It really depends on your reason for owning it. To me, this is an important factor because it strikes at the heart of why I bought BTC in the first place. This was for a few reasons, but a primary of which was diversification. Yes, I see a future for crypto and I wanted to ride the popularity trend, but I was also looking for a way to reduce some of my equity exposure and lock in profits after a tremendous post-bear market surge. BTC seemed like an asset to check off a lot of my boxes, so I went with it (albeit a relatively small position).
The bad news is this relationship between stocks and BTC has been consistently rising with time. When the coin first became popular, the relationship was weak, oftentimes it was even negative with the S&P 500, which is ideal for hedges in my view. During the worst of the Covid pandemic, this relationship soared to its highest positive correlation ever. Granted, it has softened somewhat since then, but the correlation still remains well above the lows we saw in the early years of popularity:
Now, I want to emphasize this is not inherently a “good” or “bad” thing. It depends on one’s perspective. Some might view this positively because it means BTC’s price action is normalizing and getting more credibility. To be fair, those are generally positive attributes. But for me, I am lukewarm on this development because of my reasons for buying BTC in the first place. This was to provide myself with a hedge against equity sell-offs. If BTC is going to trade more in line with stocks, then my thesis breaks down. This reality is making me reluctant to put more cash in this asset class, despite the rapid fall in price we have seen of late.
Risk Assets At-Risk From Fed Tightening
Expanding on the above point, a worrisome result of BTC trading more like the S&P 500 is that it has become less immune to the actions of central banks. The Fed’s moves to raise interest rates this year (along with other central banks around the globe) are punishing growth names and risk-on assets alike. This is partly why the correlation between BTC and the Tech-heavy S&P 500 index is markedly higher – both being driven down by some of the same macro-forces (Fed tightening and rising yields).
The concern here is that this pressure is not going to abate as we move deeper into 2022. The Fed has so far only moved its benchmark rate by .25 basis points – a relatively dovish move despite the hawkish rhetoric and rapid rise in inflation. Some market participants expected a .50 basis point move, although the turmoil in Eastern Europe probably gave the Fed some pause. Yet, inflation remains extremely high, which is going to force the Fed’s hand if this trend doesn’t change:
As the above graphic shows, inflation’s acceleration has only gotten worse as 2022 has gone on. This has made market participants expect much more Fed hiking to occur. At the time of writing, the market is predicting a full 2% move in the benchmark rate. With only .25 of this move occurring so far, that means we are likely to see a lot of action by the Fed before the year is done:
The takeaway here is a simple one. Fed tightening is going to get more aggressive. Leading up to this reality is going to make investing in riskier trends more difficult. This includes BTC, along with many other assets. While I am not being an alarmist “sell” predictor here, it does suggest to me investors need to be increasingly more cautious. This is a time to stay within risk tolerances and comfort zones, so readers don’t find themselves over-extended if these assets move south.
Regulation Getting Less Friendly
Another point of concern for me is coming out of regulators, especially foreign governments. In a prior review of BTC, I highlighted why I saw forthcoming regulation as a positive trend. I believed this would improve the credibility of the asset, and ultimately open the door up for investors who were on the fence with this investment type to dive in.
In fairness, this did happen to a degree. The number of Americans investing in crypto, as well as those who are becoming more familiar with it, continues to grow. This is an undeniable positive for the space. Yet, much of the headline regulation that has come out from developing countries especially is not the type of managed regulation I was hoping to see. The Chinese government made waves last year with crackdowns in the industry and a ban on the mining of the coin. Since then, we have seen other nations follow with strict measures, such as the most recent action by the Thai government less than a month ago:
Fortunately, the regulations coming in closer to home in the U.S. are not quite as ominous. While it is a bit unknown what the end result is going to be, the current administration is taking aim at regulating it with a lighter touch than what we have seen in Asia so far. For example, President Biden has recently directed federal agencies to implement a strategy for policies and regulations on digital assets (i.e. crypto).
On this backdrop, the SEC and U.S. Treasury Secretary Janet Yellen have echoed similar sentiment. Yellen was quoted as saying regulation should be “tech neutral”, which can be interpreted as meaning digital assets should not have overly burdened by excessive regulations in excess of what the traditional banking system faces. This is broadly a positive for crypto.
Similarly, SEC Chairman Gary Gensler announced initiatives the SEC is looking at to expand investor protections. Items include separating out asset custody to minimize investor risk. This protects investors because then assets are segregated and not used by the exchanges for day-to-day operations. Also, it can make hacking scams more difficult, in theory. With major hacks constantly making headlines across the globe, this is extremely important.
Ultimately, I view U.S. actions in a favorable fashion, consistent with my prior view that reasonable regulation is a tailwind for the sector. However, this is balanced by the negative developments in other countries. This is a global asset, so what happens in China, Thailand, or anywhere else has important implications for BTC’s price. This push-pull dynamic is again a support for my more modest outlook going forward.
The Youth Factor Is A Positive
For this review, I specifically focused on some of my areas of concern. But I want to balance this out by speaking now of some positives. After all, I am not advocating outright selling of BTC, or any cryptocurrency for that matter. This is still an emerging asset class, and the future presents plenty of opportunities as well as risks.
One positive of importance is how crypto is viewed along demographic lines. The primary believers in crypto, and BTC by extension, are younger individuals. In fact, a majority of those aged 18-49 are of the belief crypto will be a dominant economic force in the future:
The conclusion I draw here is this is a tailwind for crypto. Younger Americans see the legitimacy of this asset class and will be around for a long time to invest in, benefit from, and take part in this revolution. Further, especially for the youngest part of this demographic, they are nowhere near their peak earning years. In particular, as members of the 18-29-year-old cohort graduate college, move into careers, and progress, this will open up their incomes and disposable assets to invest in this growing sector. That provides a theory that future-depend from retail investors will rise, not decline, as we move deeper into this decade.
This year has been full of ups and down, whether one is buying stocks or crypto (for bonds, it has been essentially all down). This has pushed BTC’s price back to levels that first got me interested in the asset back in 2021. At this juncture, there is increasing scrutiny by global governments to limit the extent consumers and households can use these assets. This is a worrying trend, although the fortunate part is the U.S. is taking a more collaborative approach, helping to balance out some of the regulatory risks facing crypto.
Therefore, there is plenty of good and bad to manage. BTC is getting more correlated with risk-on U.S. equities, and that is going to cause some pressure as Fed tightening and geopolitical risks dampen investor sentiment. However, readers may be interested in knowing that, on a relative basis, BTC is actually getting less volatile than a popular growth/tech U.S. index. If we look at BTC’s performance so far in 2022 compared to the NASDAQ 100, we see the NASDAQ 100 has actually had more days of major swings:
From this perspective, BTC actually looks like a relatively safer play, which is difficult to even comprehend for those watching the currency since inception.
In any event, there is a lot to digest here, and no real path to forecast a bull or bear case. When I research ideas and am not able to come up with a clear conclusion, I don’t try to force something that isn’t there. If there isn’t a trade to make, don’t make it, and that is basically how I feel about BTC at the moment. Will I sell my current holdings in fear of further regulation or Fed hikes? No. But will I be buying more on the basis of young investor enthusiasm and stronger correlations to U.S. stocks? The answer is also no. My take here is to remain in a holding pattern for now, and initiate a larger position when the outlook is clearer or the twice drops (or both). Therefore, I will be biding my time on BTC, and suggest readers approach new positions cautiously at this time.