January Effect? Bitcoin Tightens Correlation with S&P 500

Analysts say January is the key month to watch when trying to predict end-of-year returns
If stocks are down in January, “it’s going to be hard for bitcoin to rally,” Nicholas Colas at DataTrek Research told Blockworks

Bitcoin and equities kicked off the second trading day of 2022 higher. Based on recent data, this trend may continue as bitcoin is starting to move more in tandem with the S&P 500.

With January tending to be a key month to gauge how year-end returns might look for equities, cryptocurrency fans should keep an eye on the S&P for clues on how bitcoin could end the year, Nicholas Colas, co-founder of DataTrek Research, said.

“If stocks are down in January, though, it’s going to be hard for bitcoin to rally,” he said.

Positive momentum for stocks

The S&P 500 ended 2021 26.89% higher. Based on historical data, analysts are mostly calling for another year of positive returns, although perhaps not as high as 2021, according to Tom Essaye, founder of Sevens Report Research.

“I imagine that stocks can trend higher, but I don’t expect another 27% year in the S&P 500, I don’t think many people do,” said Essaye. “As we sit right now, the fundamentals and momentum are certainly positive for stocks.”

The past nine times that the S&P 500 has posted annual gains of more than 20% have resulted in a positive finish for the subsequent calendar year, meaning there is a good chance that the index will finish 2022 in the green, Colas said.

Jessica Rabe, DataTrek Research co-founder, says the January effect tends to start early in the month. “The S&P is up during the first 5 days of trading during most years, and generates over double the annual return of years versus when it was negative during the first week of trading,” she wrote in a recent report.

Despite starting Tuesday’s session in the green, the S&P 500 was trading down 0.24% year-to-date as of market close on Jan. 4, 2022. Bitcoin was also down about 4% year-to-date.

The bitcoin correlation

The correlation coefficient of bitcoin and the S&P 500 was 0.35 as of Jan. 3, 2022, meaning that the two assets are moving more in sync than typically expected. A coefficient of 1 would mean the assets are moving together, a coefficient of -1 would mean they are moving in opposite directions.

Historically, the correlation between bitcoin and the S&P 500 has fluctuated. Following bitcoin’s 2018 crash, the coefficient dipped as low as -0.22, according to data from CoinMetrics. During the more recent pandemic-induced sell-off of March 2020, the coefficient rose as high as 0.4

The correlation between bitcoin and the S&P 500 has been trending upward since June 2021.

Bitcoin volatility continues

Bitcoin ended 2020 more than 300% higher. The largest digital currency’s 2021 gains were a more modest 60%. Large swings in annual returns is nothing new for the digital asset. The token closed 2018 more than 72% lower before coming back in 2019 to rally more than 87%.

“Bitcoin’s volatility? That’s not going away this year,” said Colas.

The key area to watch is going to be the Federal Reserve, Essaye said. Speculative areas of the market, like crypto and big tech stocks, are likely to feel the pressure of higher interest rates and pullback in federal support, he added.

“For the first time since 2018, we enter the year where the Fed is going to be hiking rates and removing accommodation,” said Essaye. “And what does that do to the markets and to the economy? That’s the million-dollar question for 2022.”

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