October Market Correction: Bitcoin The Winner

There are few days left before we close the record on October but it is proving to be a rough one. Historically the Halloween month has been especially difficult for the stock market. More corrections, crashes and crumpled fenders have taken place than any other time.

Through the close of trading on Wednesday, the stock market took a bruising. The S&P 500 was off nearly 10% for the month. The technology heavy NASDAQ was even worst losing over 12%. Both in terms of the breadth and magnitude, October qualifies as a stock market correction.

Another month like October and officials of the technical community will be declaring the end of the longest bull market in the history of mankind. It would indeed be a sad time as the party has been wonderful everyday of its existence.

Relative Value Hasn’t Matter

The fact that cryptocurrencies have lost far greater value in 2018 than US stocks hasn’t mattered this October.  Of the five largest cryptos measured by value, two of the five, Ripple (XRP -19%) and Bitcoin Cash (BCH -17%) underperformed. Ether (ETH -12%) matched the NASDAQ. EOS down only 5% was a standout but the biggest winner was the smallest loser: Bitcoin (BTC -2%).

Adding up all the evidence tells us that any notion of investors being attracted to cryptocurrencies because they offer better value than stocks has been totally wrong. As one of the bigger advocates of the relative value concept, that causes me to admit having missed something other than simply the wide gap in prices.

Good Concept-Bad Timing

Being at the right place at just the right moment can make anyone look smart. The weakness with value investing in crypto right now is the absence of a body of kindred spirits.  Surveys continuously show the character of investors is different.

Most surveys show that only about 8% of Americans own any crypto, of which 80% prefer Bitcoin.  Most of these folks are trend followers, buying as prices are moving higher and selling on the way down. The so called whales that logic dictates would form the core of value investors are little help either. Research indicates this group is far more passive long term and much less active in trading than generally perceived.

Legitimizing Institutional Access

As we approach the end of 2018, the role of institutions in the crypto market is becoming potentially explosive.  As this takes place, the search for value is likely to get much more attention resulting in higher prices across the board.  Here are two important reasons to take this point seriously.

Security and legitimacy are terms that have been keeping institutions away from involvement. For pension funds and other fiduciaries, nothing could be worse than investing in Bitcoin and getting hacked and losing everything.  

This week, the New York State Department of Financial Services licensed a sub of Coinbase to operate a qualified custodian for up to six major cryptocurrencies.  This may not sound like much, but it is. Henceforth, anyone acting as a fiduciary can point to NYDFS as the responsible regulatory body. This may not sound like a big deal, but it is. The approved currencies include Bitcoin, Bitcoin Cash, Ether, Ether Cash, Ripple and Litecoin.

And the launch of Fidelity Digital Asset Services, announced on October 15, is another giant step after the NYFS.  FDAS aims to provide custody and trading services for institutional clients. Fidelity is one of the five largest financial services providers in the world, maintaining some $7.2 trillion in client assets.

These announcements have Wall Street’s attention, so other big name institutions will follow shortly. Fidelity hopes to draw institutional investors, including hedge funds, family offices and market intermediaries. Conservative fiduciaries may be slow to react but a flood of hedge fund money is likely to follow. There is one simple reason: performance.

Hedge Funds Feeling The Pressure

Forbes Magazine once placed the capital handled by hedge fund managers at $2.4 trillion. This is an astonishing amount of money.  There is one thing even more impressive – comparing this number to 10 or 20 years ago. Hedge funds have grown faster than their ability to produce premium returns. According to the HFRI Weighted Composite Index, over the past 36 months ending September 2018, returns have been a meager 5.34%.  

Even with the dismal 2018 performance of crypto, the HFR Blockchain Index produced a 267.37% 36 month return while the HFR Crypto Index gained 274.76%.  The combination of increasing security/legitimacy and relative performance makes a strong case for underperforming hedge fund managers to offer their investors.

This year is likely to end with lots of unhappy crypto investors but the period ahead is likely to change things considerably.

Featured image courtesy of Shutterstock.

James Waggoner is a veteran Wall Street analyst and hedge fund manager who has spent the past few years researching the fintech possibilities of cryptocurrencies. He has a special passion for writing about the future of crypto.