Why bitcoin's brutal drop from an October record high is now a crucial barometer for the broader market
By Joseph AdinolfiThe pioneering crypto has been a leading indicator for the stock market lately. Does that mean the selloff has legs?Is bitcoin a leading indicator for the stock market?U.S. stocks staged a furious comeback rally on Friday as investors once again swooped in to buy the dip ahead of the weekend. Bitcoin prices, on the other hand, continued to sink.The rebound helped save the Nasdaq Composite COMP from what would have been its worst weekly percentage-point decline since April. But the index still tallied a third-straight weekly decline, while the S&P 500 SPX and Dow Jones Industrial Average DJIA fell for the second week in three.For all of the pain in the stock market since the start of November, bitcoin prices (BTCUSD) have seen an even greater decline. Since tagging a record high of $126,272.76 a coin on Oct. 6, bitcoin prices have plummeted by about 33%. They traded at $84,535 Friday afternoon, its weakest 4 p.m. Eastern Time level since April 18, according to Dow Jones Market Data. That represented a drop of 2.1% on the day.The drop from the peak has been the largest pullback for bitcoin since the U.S. Securities and Exchange Commission approved a spate of spot bitcoin ETFs early last year. These funds are allowed to hold bitcoin directly, rather than solely invest in futures.The fact that bitcoin has continued to slide was making some market participants uneasy on Friday. The correlation between stocks and bitcoin has been climbing. Meanwhile, popular sentiment gauges for both stocks and bitcoin continued to flash warning signs, despite Friday's bounce.A leading indicatorThis could be a problem for investors going forward.The big question heading into next week is whether bitcoin will continue to serve as a leading indicator for stocks, said Hardika Singh, an economic strategist at Fundstrat Global Advisors.Stocks and bitcoin don't always move in lockstep. But they have lately. That's left some on Wall Street wondering if bitcoin's failure to catch a bid on Friday might hint at more losses for stocks next week."I tend to look at bitcoin as a sentiment indicator, and there has been such poor sentiment everywhere lately. The thing here is that bitcoin is the poster child for bad sentiment. That's what it is showing us right now," Singh said during an interview with MarketWatch.Over the long term, stocks tend to trade on fundamentals, but over a period of weeks or months, sentiment often sits in the driver's seat, Singh added."When you see bitcoin pivot, well, that should maybe give you some confidence that the equity market can also pivot," Katie Stockton, founder of Fairlead Strategies, told MarketWatch.Another factor weighing on investors' confidence: For the third week in a row, dip buyers flooded back into the stock market on Friday. Each time, volatility returned the following week.Liquidity issuesSome on Wall Street have cited a common denominator driving trading in bitcoin and some stocks, most notably speculative plays like those focused on quantum computing.Liquidity in the U.S. financial system has been ebbing lately, said Jose Torres, a senior economist at Interactive Brokers. Reserves in the banking system have been declining lately. At the same time, use of the Fed's standing repo facility - seen as a liquidity spigot for financial institutions in search of short-term cash to finance their operations - increased in late October."Bitcoin is getting slammed because worsening liquidity conditions gauged by financial institution reserves and the increasing use of the standing repo facility together depress speculative activities," Torres told MarketWatch via email. Use of the facility rose Monday, but then dropped off later in the week.See: Bitcoin has been sliding. These charts show why - and what might happen next."The overall weakness in the crypto space is indicative of a softening retail bid, which portends lighter buying forces for U.S. stocks in the short-run, especially the higher beta areas," Torres said. High beta stocks are generally more volatile than major indexes like the S&P 500.U.S. stocks finished solidly higher on Friday, with the S&P 500 gaining 1%, while the Nasdaq Composite rose by 0.9%. The Dow Jones Industrial Average gained 493.15 points, or 1.1%, at 46,245.41.-Joseph AdinolfiThis content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.