Bitcoin might help explain the recent turbulence in stocks, far-fetched as that sounds. Consider a new piece of analysis from Morgan Stanley’s stock strategy team.
The recent market correction began after U.S. share prices peaked on Jan. 26, but speculative fervor might have hit its highest point more than a month earlier. The forward price-to-earnings ratio for Standard & Poor’s 500 index topped out on Dec. 18.
Bitcoin peaked the same day. Coincidence? Hang on.
Dec. 18 is significant for a third reason. It was the day before the U.S. Senate passed sweeping tax cut legislation.
Shares kept rising for weeks after the PE ratio hit its high only because earnings estimates were revised upward even faster than the PE ratio was declining. In the first weeks of January, what investors viewed as the best start for the stock market since 1987 looks a lot like Wall Street adjusting its math for the tax cuts.
“We think the passage of tax cuts coincided with peak excitement, at least in terms of price/valuation and “speculation” as represented by things like Bitcoin,” wrote Morgan Stanley’s strategists in a Monday report.
With the cuts passed, investors are adjusting to the likelihood of faster economic growth, at least in the near term, and higher interest rates. Those higher rates can come from a pickup in inflation, or from a worrisome widening of fiscal deficits, or both.
Whatever the reason, higher future bond yields threaten to make stocks look incrementally less attractive by comparison. At the same time, the economy and corporate earnings growth look healthy. That points to a continued rise for shares, but perhaps a decline in the market’s PE ratio.
Even though earnings underlying the S&P 500 are expected to grow 19% this year, perhaps investors will end up with only a single-digit price gain for shares. Morgan Stanley’s year-end target of 2,750 works out to a 5% price gain from here, or a full-year gain of about 8%.
Investors could learn more about where bond yields are headed when inflation figures are released on Wednesday morning. If Bitcoin has indeed become a leading indicator of speculative excess, perhaps even investors who view it as folly should keep an eye on it.
Early Monday afternoon, Bitcoin was up nearly 7% and the S&P 500 has risen 1.5%.