Bitcoin’s Fading Action Is A Huge Warning For Market Liquidity (Cryptocurrency:BTC-USD)

Bitcoin (BTC-USD) ups and downs in price since inception can almost entirely be traced to two factors – financial system liquidity changes and investor desires to own a “decentralized” digital currency as a hedge against fiat money printing. Honestly, without deficit-happy government spending around the world, I doubt Bitcoin would have a good reason to exist.

Believe it or not, this makes Bitcoin (and other cryptocurrencies as a group) an excellent indicator of future stock market action, functioning as a grand risk-on money flow indicator. When you do the research, Bitcoin tends to lead the stock market for trend (both up and down), by varying degrees over its short history from invention in January 2009.

In terms of confirming the U.S. stock market’s S&P 500 rise to new all-time highs in May 2024, problems are developing. Bitcoin has actually failed to keep pace with equity trading gains since the 2021 top, and has lagged badly for percentage performance since March of this year. What this may be telling investors is net liquidity has been shifting from excessive levels of money floating around the financial markets (which helped propel price above $73,000 in March) to something akin to tightening credit conditions.

It could be a signal: (1) consumers have spent all of their COVID pandemic stimulus-check windfall in aggregate, (2) continuing high rates of 4% inflation are sapping wealth and confidence, and (3) the negative effects of an inverted Treasury yield curve over 18 months are finally squeezing bank lending as a whole (measured since October 2022, looking at 3-month vs. 30-year securities).

Another worry, 2023-24 Federal Reserve “promises” of lower interest rates may prove illusory until a recession sends inflation back to the central bank’s 2% stated goal. If anything, inflation rates appear to have bottomed in the 3% to 3.5% YoY range during early 2024, as numerous commodities have jumped in price since March and wage growth remains stubbornly high.

So, if the logical trading conclusion is Bitcoin peaks first when system liquidity is highest, the absence of a new record in May with the S&P 500 all-time move should leave observers a little concerned. Looking into the future, Bitcoin “should” slide faster in price before the S&P 500 is hit hard by selling over coming months. This trading assumption fits in nicely with evidence of a slowing economy in April-May. Let’s review past Bitcoin to S&P 500 patterns.

The Historical Trading Evidence

The main point I want to highlight in this article is Bitcoin has a history of peaking before the S&P 500 index, represented by the SPDR S&P 500 ETF (NYSEARCA:SPY). Unfortunately, it doesn’t have much of a track record for predicting exact equity market bottoms.

When liquidity conditions are clearly tightening through rising interest rates like in 2018-19 or 2022, Bitcoin has been a horrible investment to own. A cautionary note for Bitcoin bulls is we don’t have much trading history on what it will do during a severe and prolonged economic downturn, since its only recession experience was the short-lived 2020 pandemic period.

My statistical analysis for this article starts with a longer-term chart comparing trading action between the two asset classes back to June 2017. At this moment, Bitcoin was reaching conversation in the mainstream media on strong price gains. The bottom section is my bread-and-butter focus, where I am graphing Bitcoin price action “relative” to the S&P 500 index.

The overriding problem for Bitcoin perma-bulls is the U.S. stock market has bested digital cryptocurrency performance since May 2021 (the majority of cryptos have risen even less than Bitcoin), a good three years ago. Had you sold your crypto positions and exchanged them for an S&P 500 ETF 36 months ago, you would have more money in your pocket today.

I am viewing this long-term situation as a liquidity non-confirmation of the 2024 all-time highs in the U.S. stock market. Sure, the S&P 500 is higher than late 2021 (with gains led by a handful of Big Techs), but underlying liquidity in the financial system is the same or lower. Moving short-term bank interest rates from ZERO to 5%+ over this span has something to do with it.

2018

Perhaps more interesting and useful in today’s conversation, we can review the month-to-month changes in Bitcoin vs. the S&P 500. If we travel back to late 2017, Bitcoin spiked in price then tumbled throughout 2018. I have marked with a red circle, the “lead” time cryptos gave investors to be careful in portfolio weightings to equities. Two months later, the S&P 500 fell -10% in price over a week.

Again, during September 2018, the stock market reached new all-time highs, not confirmed by Bitcoin. A -20% bear market ran its course into late December bringing Wall Street back to early 2017 quote levels.

For reference, between December 2017 and December 2018, Bitcoin collapsed -85% in price!

2019-20

Again, Bitcoin peaked relative to stocks in June 2019 (circled in red). The stock market would continue higher for another six months, despite severely tightening credit in the financial system including a minor Treasury yield curve inversion. Then the COVID pandemic showed up, with mandated economic closures creating a recession. The S&P 500 erased several years of gains over two months, imploding by -30%.

Bitcoin would end up tanking -70% in price between June 2019 and March 2020!

2021-22

The pandemic-induced government money printing, debt relief, payroll loans and direct check handouts pushed “liquidity” to new modern highs in America during 2021. Both Bitcoin and the S&P 500 welcomed monster bull moves on the bailouts starting in April 2020, that truly accelerated in the first part of 2021. Bitcoin peaked in March of that year (circled in red) on a relative basis (stocks would rise faster after this point), indicating liquidity was getting overcooked. Yet, the S&P 500 would move in a positive direction for another nine months into yearend.

What we learned… less aggressive gains in Bitcoin presaged trouble ahead for stocks, while the January-October 2022 period proved quite difficult for Wall Street. The S&P 500 index fell around -25% measured from top to bottom, while Bitcoin was hit with a -75% shellacking from its November 2021 nominal peak.

2024 (Present)

That’s why investors need to keep an eye on Bitcoin prices going forward, even if you don’t own cryptocurrencies. The March spike in Bitcoin on groundbreaking SEC ETF approvals may have marked another high-water mark for cryptos (circled in red).

If Bitcoin and digital cryptos succumb to heavy selling in June-July, the stock market outlook will sour dramatically for the second half of 2024 and early 2025. The “Sell in May, and Go Away” calendar-timing mantra may prove very prophetic this year. I guess we will find out soon enough.

Final Thoughts

If you are bullish on U.S. stocks, you should be cheering on Bitcoin, plain and simple. Given immediate-future Bitcoin and crypto market weakness, liquidity in the financial system could be moving into reverse.

Assuming liquidity dries up, stock market gains will be incredibly difficult to achieve in my view. Standing near a modern-record 3x price to sales and 5x price to book value ratio for the S&P 500 names, with completely inflated equity valuations as a function of 10-year cycle-adjusted earnings (the Shiller CAPE Ratio), downside potential is exceptionally large for Wall Street the remainder of 2024. Don’t kid yourself.

Different measures of liquidity have been going in the wrong direction all year. Below is a graph of performance from the Dow Jones Transportation and Utility Averages, plus Vanguard Real Estate ETF (VNQ), iShares 20+ Year Treasury Bond ETF (TLT), and Nasdaq Bank Index. The opposite of flashing green on a healthy stock market advance by blue chips in America, lagging performance from these sectors may be hinting a contraction in market liquidity and the economy is close at hand.

Please don’t assume stocks cannot or will not fall hard into 2025. If a recession is next, with quickly falling liquidity in the financial system, the idea of investment “risk” should not be discounted lightly. Under this scenario both the S&P 500 and Bitcoin pricing could move backwards in lockstep for many months. Liquidity crunches do not mix well with extended valuations. Just ask investors in 1929 or 1987 or 2000 or 2022 how things worked out. The fascinating part of the 2024 investment equation is we just experienced a similar macro trading setup in 2021.

Are major price drops guaranteed for both? No, but further Bitcoin declines from $68,000 today will only add to the argument real trouble is coming for Wall Street, perhaps sooner than most are prepared for.

For some peace of mind, I suggest owning hedges like rising gold/silver bullion, above-normal weightings in cash earning sizable yields of 5%+ today, index put options (which are available at the cheapest premiums for downside protection in many years right now), and even some short positions to offset potential macroeconomic headwinds in your portfolio. I personally hold ProShares Short QQQ ETF (PSQ) and ProShares Short S&P 500 ETF (SH) stakes in my tax-deferred accounts as a way to both earn yield and protect against equity downside. I have talked about their double-duty advantages in the current market setup, PSQ here and SH here.

Thanks for reading. Please consider this article a first step in your due diligence process. Consulting with a registered and experienced investment advisor is recommended before making any trade.