More Pain May Come to the S&P 500 and Nasdaq. Bitcoin’s Fall Is a Bad Sign.

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Stock market investors could be watching the latest cryptocurrency carnage with a touch of schadenfreude. That may be short lived: for all its worth, Bitcoin has proven to be a leading indicator of risk sentiment, and its latest decline could bode ill more broadly.

Bitcoin
prices were down 7% over the past 24 hours to below $26,400, having earlier bottomed out below $25,500 to mark the lowest levels since mid-June. Some crypto traders are pointing fingers at the revelation reported late Thursday that

Tesla

(ticker: TSLA) CEO Elon Musk’s SpaceX firm has written down the value of its Bitcoin holdings and has sold the token. That’s one possibility.

There may be a more mainstream explanation, however—and it could spell trouble for the S&P 500 and Nasdaq.

The alternative to blaming Musk is blaming the macro backdrop. Stocks have sold off and bond yields have risen in recent days as investors increasingly brace for the Federal Reserve to keep interest rates at generational highs for longer as the central bank continues to battle inflation. 

Higher rates and yields are bad for Bitcoin, just like all risk-sensitive assets including equities. If investors can get 5% annual return from Treasuries, there is little incentive for money to flow to riskier bets like Bitcoin or tech stocks.

If that’s the driving force behind Bitcoin’s fall, brace for more declines in stocks. For all it’s worth—and some say that’s very little—Bitcoin has proven to be an excellent leading indicator of risk sentiment in wider markets.

Consider: Bitcoin’s recent peak was hit on July 13, while the

Nasdaq Composite
recently topped out on July 19, and the

S&P 500
followed on July 31. With Bitcoin being higher up the risk curve than most tech stocks, and tech stocks tending to be higher up the risk curve than the wider S&P 500, this makes some sense.

Now, Bitcoin is down around 16% from its July 13 zenith. The Nasdaq has fallen 7% since July 18, with the S&P 500 almost 5% lower since July 31.

This is far from sophisticated technical analysis—just a view that Bitcoin is further up the risk curve than stocks and has shown in the past to lead wider risk-sentiment. While stocks have already fallen significantly in recent sessions, the most recent dip in Bitcoin prices—which are now below key technical levels and vulnerable to further declines—could spell that risk sentiment for stocks has not yet hit rock bottom.

And some market participants are coming around to the view that wider caution is due.

“We might be seeing more marketwide caution amid signs that broader growth could be slowing,” said Andrew Lawrence, CEO of custody group Censo and a former partner at crypto hedge fund Pantera Capital. “The inflation narrative might be giving way to a growth scare … rates, after all, are still relatively high and we might only now be feeling the delayed impact of the very rapid rate increases.”

It’s worth considering if investors are inclined to explain-away Bitcoin’s declines as just more characteristic crypto troubles.

Write to Jack Denton at jack.denton@barrons.com