S&P 500 & Bitcoin: A Tale of (Opposite) Volatility
“Stability leads to instability. The more stable things become and the longer things are stable, the more unstable they will be when the crisis hits.”
– Hyman Minsky
It is hard to to imagine two more disparate asset classes than the S&P 500 and Bitcoin (“BTC”). The first is the bellwether of global equity markets and the epitome of “blue chip” investing while the second is the upstart, commanding attention amidst a flurry of controversy and criticism. When it comes to volatility the difference between the two is even more extreme.
2017 will go down as the least volatile year in the history of the S&P 500. For the longest time in its 60 years history, the index has not had a 3% decline as the last one was 380 sessions ago as the time of this article. It has been 508 days since the last 5% decline and almost two years since a 10% or more decline. The VIX, one of the most common measures of volatility, has been into a secular decline and reached on November 3rd its lowest level ever. In essence the volatility of the S&P 500 has vanished and the most important equity index in the world, representing the who’s who of the most valuable global corporations, has become almost as predictable as a government bond.
On the extreme other end of the spectrum, extreme volatility has been the hallmark of BTC. With a standard deviation of 4.36 vs 0.43 for the index, BTC is ten times more volatile than the S&P. Consider this; while the S&P appears unable to decline even a meager 3%, this year only BTC had five corrections greater than 20%. Not an asset class for the faint of heart. Yet as adoption starts to grow, volatility is also appearing to subside and it is now about one fourth of what it was in back in 2010–11.
Volatility however does not tell the whole story and it has to be seen in the context of return. Even better, a more important measure of both volatility and return is the combination of the two. The Sortino Ratio is probably the best measure of risk adjusted return as it only considers “bad” (i.e. downside) volatility as a way to contextualize returns. For the S&P 500 the rolling two years Sortino Ratio is 1.7. Not a bad result and significantly better than Gold (0.94 ), Bonds (0.3) and Emerging Markets Equities (-2.09). Yet BTC’s Sortino Ratio is 3.7, more than twice the S&P 500. In other words over the last two years BTC has returned, if the risk level is held constant, 218% more than the S&P.
Could there be a connection between the volatility of the $23 trillion behemoth, one of the most widely owned asset in the world, and the “tiny” $120 billion new kid on the block? While showing no sign of any statistical correlation, the fluctuation of the two assets may have more in common than you think.
The drop of volatility for the S&P may appear inexplicable, especially if seen in the context of skyrocketing valuation and the risk of credit tightening. On the contrary, the seemingly lack of concern in the market is the very byproduct of the extreme monetary policy implemented in the throes of the Great Financial Crisis of 2008 (“GFC”). The arguments are well known and part of mainstream narrative: ultra-low interest rates have pushed investors to take increasingly higher risks and expanded valuations beyond the historical norms and to exceptionally high levels. The same policies have stimulated increasing level of debt driving stock buybacks, higher bond prices, real estate etc.
More than ten years on and with a much larger stock of debt than what lead to the GFC, market participants have been conditioned to believe that loose monetary will continue for a very long time. Furthermore the unspoken but widespread perception is that any future instability will be met with more intervention to stem the price decline and prevent a debt default chain reaction of global proportions. Put it simply, participants do not believe there is a material scope for prices to fall and widespread FOMO have conditioned markets to “buy the dip”. That has, in turn, vanquished volatility.
The narrative is the same but opposite for BTC. Inherently decentralized, the blockchain-based asset has been on a rollercoaster dodging life-threatening bullets. Governments hostility, uncertainty about the technology, bad actors and competition from other crypto assets have not been able to thwart BTC’s adoption. On the contrary, all such challenges, appear to have strengthen the case for the resiliency of the crypto asset as its market cap grew from $15 billion in January to $120 billion as of the date of this note.
In a world awash in debt, the probability of massive devaluation of fiat currency looks uncomfortably high as it would reduce debt stock in real terms while minimizing the scope for more traumatic (not to mention politically inconvenient) type of default. The Japanese model if you like, only this time on a planetary scale. As the possibility of that kind of scenario grows, savers are starting to take cover and seeking central bank-resistant assets. An ideal set-up for BTC, an investment that correlates with the lack of confidence in central banks. The S&P 500 on the other side is exactly the opposite, as price increase is driven by the belief that monetary policy will continue to prop asset prices regardless of fundamentals.
Albeit uncorrelated, the S&P 500 and BTC’s price action are therefore both ultimately the product of monetary policy. More importantly, the two narratives are not mutually exclusive. Think “feedback loop”: the more central banks continue to prop asset prices, the more likely is that such policies will eventually result in the debasement of fiat currencies hence validating the case for BTC. The caveat of course is that, at some point in time, the value of the two asset classes will dramatically diverge in “real terms”. Volatility may be the harbinger of such eventual outcome.
In the work of economists such as Minsky and Taleb but also as observed in natural sciences, adaptability is the hallmark of stronger specimens and it is critical to long term survival. That is why the panda, only feeding on bamboo shoots, is at risk of extinction and the rat is not. On the same token, the lack of volatility in the S&P does not bode well for its “real terms” future value. In other words, we may see the S&P 500 at 10,000 but perhaps, at the same time, paying $20 for a coffee.
In conclusion, to paraphrase Nassim Taleb, the S&P 500 and BTC is ultimately a tale of “fragile” against “anti-fragile”. The latter always prevails.
Pietro Ventani is a Singapore-based asset allocation strategy advisor and a private equity/VC investor. He purchased his first bitcoin in April 2013.
