Stock market during election years: does it affect crypto markets?

Does the stock market only go up during election years?

This is a common question most traders will have, especially as we approach the 2024 U.S. elections. While there have been cases of significant market gains in election years, historical data shows a more nuanced picture, as factors like political uncertainty, policy shifts, and economic stimuli are thrown into consideration.

This article will explore the factors that influence market performance during elections, examine current market dynamics with specific examples, discuss potential scenarios for the upcoming election cycle, and offer insights on how it may impact the crypto market.

TL;DR

• The performance of the crypto market during election years is unpredictable, influenced by regulatory uncertainty, political rhetoric, and economic policies, with varied outcomes based on these factors.

• Crypto has shown a high correlation with stock markets, partly due to new financial products like spot ETFs and broader market dynamics influenced by interest rate policies.

• Changes in crypto regulations can significantly affect the crypto market. Supportive policies may boost growth, while restrictive regulations can stifle development and create volatility.

• Economic policies like tax laws and fiscal stimulus play a crucial role in determining crypto performance during election years. Positive policies can drive growth in the crypto sector, while economic instability or restrictive measures can lead to market caution and volatility.

• Crypto is sometimes viewed as a hedge against election-year volatility due to their decentralized nature, which can make them less susceptible to government regulations compared to traditional assets.

Is crypto correlated to stocks?

Source: TradingView

Before diving into the nuanced relationship between stocks and crypto, it’s key to first establish their correlated nature. Previously demonstrated in our Bitcoin vs S&P 500 comparison, an updated look at both BTC and the S&P 500 reveals that they remain highly correlated.

To recap, this crypto-stocks correlation is largely because of the risk-on environment created by the Federal Reserve when Chairman Jerome Powell indicated a pause in interest rate hikes and possible interest rate cuts in light of declining inflation numbers.

With the introduction of both spot BTC ETFs and spot ETH ETFs, there’s now more correlation than ever as TradFi traders and institutions have easy access to an exchange-traded fund that’s representative of spot Bitcoin and Ether prices. This scenario is also supported by the massive amount of net inflows going into these spot crypto ETFs.

Understanding the relationship between stocks and crypto

The relationship between stock markets and crypto markets is a complex one that’s influenced by many factors. While a brief look at crypto vs stocks may cause the comparison to seem disparate, these two asset classes are interconnected in ways that can significantly impact their performance, particularly during times of political uncertainty such as election years.

Global market interconnectivity

The global financial landscape is increasingly interconnected, with events in one region affecting markets worldwide. This interconnectedness is particularly evident during election years, when political rhetoric and policy changes can have far-reaching consequences. For instance, a surprise election result or a sudden shift in economic policy can lead to increased market volatility. This volatility can spill over from traditional financial markets to crypto markets, as traders may seek to rebalance their portfolios or hedge against potential risks.

One example of such a global event rocking stocks and crypto alike is the Bank of Japan’s decision to raise interest rates. After more than a decade of near-zero borrowing rates, this sudden shift in monetary policy caused a massive slump in global asset markets as those involved in the Japanese Yen carry trade proceeded to unwind their cash-and-carry arbitrage to reduce the risk they were previously undertaking. Despite seeming like an isolated incident in Japan that would mostly affect forex traders, traders witnessed major drawdowns across markets, particularly in assets that are perceived as risky, like major tech stocks and cryptocurrencies.

Impact of proposed regulatory policies

Economic uncertainty is a common theme during election years, as candidates often propose differing economic policies and visions for the future. From attempting to curb the national debt to dictating corporate tax rates, the regulatory policies proposed during election campaigns can create uncertainty and volatility in the financial markets. This uncertainty can lead to increased trader caution, which can manifest as reduced demand for riskier assets like cryptocurrencies as traders adopt a more risk-averse approach.

However, it's important to note that the impact of economic uncertainty on crypto markets can vary. While some cryptocurrencies may be more sensitive to broader economic trends, others may be less affected, depending on their underlying technology and use cases.

Specific crypto-stocks correlation

To gain a more granular understanding of the relationship between stocks and crypto, it's helpful to examine specific correlations between individual cryptocurrencies and stock indices. For example, Bitcoin which is often considered the market leader in the crypto space, has shown a relatively strong correlation with the S&P 500. However, tokens like memecoins may exhibit different correlation patterns due to their high risk and light-hearted nature.

Trader sentiment and FOMO

Trader sentiment plays a significant role in influencing the relationship between stocks and crypto. Risk aversion can lead to decreased demand for both asset classes, while fear of missing out (FOMO) can drive prices upward. During times of economic and political uncertainty, trader sentiment can become even more volatile, significantly affecting market dynamics.

This was evident during the meme stock frenzy of early 2021, when the surge in popularity of meme stocks like GameStop and AMC was primarily driven by FOMO among retail traders. This trend also had a spillover effect on crypto markets, as some traders sought to pursue similar types of gains with risky assets like memecoins in the crypto space.

Historical analysis of election years and market performance

To gain a better understanding of how election years can impact stock and crypto markets, it's helpful to examine historical data. By analyzing past elections and their subsequent market reactions, we can identify patterns and trends that may provide insights into future outcomes. However, one thing to note is that while historical data can provide valuable insights, past performance isn’t indicative of future results. Market conditions can change rapidly, and factors such as global events, technological advancements, and regulatory developments can significantly influence market behavior.

The 2016 U.S. elections

Source: TradingView

President elected: Donald Trump (Republican)

S&P 500 annual performance without dividends: +9.54%

Bitcoin annual performance: +126.19%

The 2016 U.S. elections was marked by significant uncertainty and volatility as Republican nominee Donald Trump managed an unexpected win by securing enough electoral votes to become the 45th U.S. president. The surprise victory of Donald Trump as a businessman with no prior political experience sent shockwaves through financial markets worldwide. Initial reactions were largely negative as traders were concerned about the potential implications of Trump's policies for the economy and global stability. However, the market quickly rebounded and the S&P 500 experienced a modest gain of 9.54% for the year.

Interestingly, the crypto market saw a staggering surge during the same period. Bitcoin's price increased by 126.19% in 2016, outperforming traditional asset classes. This surge was likely driven by a combination of factors, including the Bitcoin halving, increased interest in cryptocurrencies, growing adoption, and speculation about their potential long-term value.

The contrast between the performance of stocks and crypto in 2016 highlights the increasing interconnectedness of global financial markets and the potential for unexpected events to significantly impact asset prices. While the S&P 500's modest gains were a testament to the resilience of the U.S. economy, the impressive performance of Bitcoin demonstrated the growing influence of cryptocurrencies in the global financial landscape.

The 2020 U.S. elections

Source: TradingView

President elected: Joe Biden (Democrat)

S&P 500 annual performance without dividends: +16.26%

Bitcoin annual performance: +304.36%

While some may market commentators may claim that 2020 was a great year for the markets based on statistics alone, digging deeper reveals many underlying factors that contributed to the stellar performance of the S&P 500 and Bitcoin. Chief among these factors was the global outbreak of the COVID-19 pandemic, which led to widespread lockdowns, economic uncertainty, and a significant market downturn in the first quarter of 2020. However, as governments and central banks implemented stimulus measures like lower interest rates to support the economy, markets began to recover and rally aggressively. The S&P 500's strong performance of 16.26% was largely driven by these stimulus measures and a shift towards technology-related stocks, which benefited from increased remote work and digitalization.

A side-effect of the low interest rates and stimulus checks was the rampant increase in speculation. Thanks to increased liquidity within financial markets, traders began seeking out riskier assets like crypto in the hopes of securing even more gains. This coincided with 2020’s Bitcoin halving, which occurred on May 11, 2020. Thanks to the amalgamation of these various bullish factors, Bitcoin enjoyed an explosive rise compared to other growth assets, closing out 2020 with a 304.36% performance.

While the 2020 U.S. elections may have played a role in influencing market sentiment, the performance of the S&P 500 and Bitcoin was primarily driven by the pandemic, economic stimulus measures, and the growing adoption of cryptocurrencies. The year 2020 highlighted the interconnectedness of global markets and the potential for unexpected events to significantly impact asset prices.

Potential factors that can influence the crypto market during election years

Political rhetoric

The rhetoric used by political candidates can significantly impact trader sentiment. Positive rhetoric can boost market confidence and lead to increased demand for both stocks and crypto. Conversely, negative rhetoric or uncertainty about a candidate's policies can create a more cautious environment and lead to market volatility. In the case of the crypto market, the impact of how both candidates want to shape crypto through their policies and frameworks will likely impact the performance of the crypto market post-elections.

With republican candidate Donald Trump claiming that he wants to make the U.S. the “crypto capital of the planet” and democrat candidate Kamala Harris being endorsed by Ripple co-founder Chris Larsen, it’s clear that both sides have plans for the future of crypto within the U.S.. The market will closely monitor each candidate’s ability to implement their proposed crypto policies, which could influence market performance post-election.

Economic policy and fiscal stimulus

Economic policies and fiscal stimulus have a significant impact on the crypto market by shaping trader sentiment and the amount of risk traders are willing to take on. Such policies can include the following.

• Changes in tax laws, including adjustments to corporate or capital gains taxes, can influence crypto trading activity.

• Fiscal stimulus packages that fund technological innovation or digital infrastructure can boost the crypto sector by fostering growth and adoption.

• Monetary policies affecting interest rates and inflation can also alter the attractiveness of cryptocurrencies compared to traditional assets.

• Policies that encourage direct investments in technology or innovation might positively influence the crypto market given the overall correlation to the stock market.

Overall, these factors contribute to the interplay between broader economic conditions and the performance of cryptocurrencies.

Crypto-related regulations

Crypto-related regulations have a profound impact on the crypto market, with both positive and negative changes leading to significant and often long-lasting effects. Supportive regulatory frameworks can foster innovation, attract institutional investment, and boost overall market confidence by providing stability and clear guidelines. In turn, this can drive market growth and technological progress. Conversely, overly restrictive regulations can stifle industry development, increase operational costs, and drive businesses and talent to more favorable jurisdictions, resulting in reduced market activity and innovation.

During election years, the potential for substantial regulatory changes introduces additional uncertainty, affecting market sentiment as traders and businesses anticipate potential shifts. While immediate reactions to regulatory proposals can create market volatility, the true impact of regulatory changes may only become evident after the election period, as new policies are implemented and industry adjustments occur. Given the global nature of the crypto market, understanding these dynamics is crucial since regulatory changes in one country can cause a domino effect in the crypto market.

Crypto as a hedge against election year volatility?

As once said by BlackRock CEO Larry Fink, Bitcoin is a “flight to quality” given the innate decentralized nature of cryptocurrencies. This decentralized characteristic ultimately makes crypto inherently less influenced by government regulation and intervention compared to conventional financial assets. This provides a layer of protection against the volatility and uncertainty associated with election years. In a season where political decisions and regulatory changes can significantly impact traditional markets, this might be the reason why some traders are pivoting to crypto as a hedge against election year volatility.

Unlike stocks and other traditional assets that are directly affected by government policies, cryptocurrencies are governed by their own protocols and market dynamics. This can make digital assets more resilient to the disruptions that can accompany political and economic shifts. Consequently, during periods of heightened political uncertainty, traders may turn to crypto assets as a more stable and independent store of value, seeking refuge from the potential risks and instability of traditional financial markets.

Final words and next steps

The relationship between stock markets and crypto markets is complex and can be influenced by various factors, including economic uncertainty and political rhetoric. While election years can create a volatile environment for crypto traders, understanding the underlying dynamics and developing informed strategies around market volatility can help navigate these challenges.

Keen to read more on how politics can impact the crypto space? Check out our guide to PolitiFi memecoins. Alternatively, you can also read our take on how real world assets are bridging the gap between DeFi and TradFi.