Experts in the financial market and the crypto industry foresee a major stock market correction unfolding in the short term. Given the high correlation of Bitcoin (BTC) with stocks observed in the past three months, there is a strong possibility that Bitcoin could follow suit.

The United States stock market has seen extreme volatility after the Dow Jones Industrial Average dropped by around 7% on June 11, led by double-digit drops of airline stocks. A confluence of three factors is seemingly triggering sizable volatility in the stock market: uncertainty around the COVID-19 pandemic, institutions moving to cash and bonds over stocks, and major geopolitical risks.

Bitcoin shows a correlation with the U.S. stock market since March

Bitcoin shows a correlation with the U.S. stock market since March. Source: Skew

Yoni Assia, the CEO of eToro — a multiasset brokerage giant that facilitates cryptocurrency trading — warned that a stock market crash may come soon: “There is a crash coming soon (in the equities market), in the next 3 weeks, someone, not sure whom, is going to sell/short their position and crash the markets. Buyers beware. Caveat emptor.”

The main reason Assia foresees a plunge in equities is because retail investors primarily have driven the stock market rally since March. He emphasized that when retail investors are behind a rally, it tends to lead to a steep correction. The trend is similar to when the price of Bitcoin hit $14,000 in June 2019 and dropped to $7,500 merely three months later, recording a 46% drop.

Assia said that even though central banks are printing more money, “we will [see] a correction since this rally seems to be fueled by speculation of retail investors. Historically these rallies end with a correction.” Speaking to Cointelegraph, Mati Greenspan, a co-founder of Quantum Economics, said:

“I agree with his [Assia’s] assessment about the stock rally being retail driven and therefore is likely to come to a sour end. I’ve been short on the stock market as of Monday. The funny thing is that the correlation between the stocks and Bitcoin has only strengthened recently and that seems to indicate that Bitcoin is being driven by institutions.”

If stocks continue to drop below key levels, the price of Bitcoin could also see a downtrend based on its reaction to the abrupt drop in the U.S. stock market. After the stock market dropped off by 7% on Thursday, the price of BItcoin plummeted by 9%, indicating that weakness in equities can affect the sentiment around other risk-on assets such as cryptocurrencies.

Declining appetite for high-risk assets

Wells Fargo’s head of credit strategy, Winifred Cisar Stieglitz, explained on Bloomberg Real Yield that investors have a significant pile of cash. But rather than stocks, she said, investors are favoring investment-grade or low-risk bonds. Institutional investors and high net worth investors see too many risks in the global stock market to build large positions on equities.

Other than existing investors in the cryptocurrency market and retail traders, the demand for Bitcoin in the last several months has come from two sources: institutions via Grayscale Bitcoin Trust and Chinese investors through the U.S.-dollar-backed stablecoin Tether (USDT). Research firm Diar reported in June 2019 that 62% of on-chain Tether activity came from Chinese investors.

In the near term, for the price of BTC to remain above a key support level at $9,100 and aim toward previous peaks at $14,000 and $20,000, Bitcoin has to see consistent demand from institutions and investors in China. If the capital inflow into Bitcoin declines and traders within the cryptocurrency market increasingly move to hedge their assets through Tether, then the likelihood of BTC following the trend of the stock market could rise.

With uncertainty around stocks, billionaires leave risk-on assets

Wall Street barons and billionaires including Mark Cuban, Paul Tudor Jones and Warren Buffett have emphasized that, in the short term, they prefer to strengthen their hedge positions and cash reserves rather than entering the stock market. On May 14, Cuban said on CNBC’s Closing Bell: “I think it’s almost impossible to predict where consumer and corporate demand is going to come from. And because of that, it’s hard to create a valuation for businesses.”

However, high-profile investors are not necessarily predicting a major downtrend in the U.S. stock market. Based on the data, they are merely struggling to set any valuation for large-scale companies due to the consequences of the coronavirus pandemic.

Fear and Greed Index across all markets move to fear

Fear and Greed Index across all markets move to fear. Source: Arcane Research

The International Monetary Fund raised a similar issue when it warned that the pandemic may skew economic data and make it hard for central banks and investors to evaluate it. In a blog post, the IMF said: “Accurate and timely economic data are crucial for informing policy decisions, especially during a crisis. But the COVID-19 pandemic has disrupted the production of many key statistics.”

During a time where policymakers and major banks are finding it challenging to properly digest economic data, it’s near impossible for both retail and institutional investors to fully comprehend the dynamics of the market. For that reason, high net worth investors have been avoiding the stock market. If they also perceive Bitcoin as a risk-on asset, the likelihood of declining institutional inflow into cryptocurrencies could rise.

The move of the Federal Reserve and other major central banks including the European Central Bank to aggressively stimulate their respective economies further indicates weakness in the global economy, which may affect the demand for high-risk assets.

European Commissioner Paolo Gentilon said he does not expect countries to veto a huge stimulus deal, suggesting countries recognize the severe downtrend of the global economy. U.S. President Donald Trump’s administration has reportedly been planning a second round of stimulus actions, anticipating the economic consequences of the pandemic to weigh heavily on both the stock and job markets.

Bitcoin’s weak technical structure

Bitcoin is at a point where a further downtrend would indicate that a strong correction is unavoidable in the upcoming months. Cryptocurrency trader Satoshi Flipper said: “Critical moment here for BTC bulls... lose this level and the next 6 months will be painful. OR flip 10.4k and ATH by year end.”

Top crypto traders fear that Bitcoin is vulnerable to a deep pullback because of the historical significance of the $10,500 price level. Every time BTC has come close to rising above it since the third quarter of 2019, it has rejected to below $7,000.

Arcane Research noted in its weekly update to clients that the crypto market tends to drop alongside the stock market. The researchers pointed out the price of Bitcoin was struggling to see volatility until stocks moved. Hence, the weak technical structure of Bitcoin combined with its tendency to see a sharp drop when equities pullback raises the probability of a prolonged correction in the near term:

“A week of sideways price action turned to the downside yesterday, as global markets dragged down the crypto market. [...] While the correlation between stocks and crypto has been decreasing lately, we can not deny the clear similarities yesterday.”

The research firm also emphasized that “uncertainty is back across all markets,” with the Fear and Greed index dropping back to the fear zone following the stock market pullback on June 11. All assets and stores of value including stocks, gold and cryptocurrencies dropped, possibly triggered by a sell-off of institutional investors taking advantage of record-high demand coming from retail platforms such as Robinhood and Charles Schwab.