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Want to know where stocks go next? Watch bitcoin

Myles Udland
Markets Reporter

If you want to know where stocks might be headed next, keep an eye on bitcoin, says Morgan Stanley’s Michael Wilson.

“We continue to think the price of bitcoin is worth watching as another signal of animal spirits,” Wilson said in a note to clients published Monday.

“Remarkably, since the peak in P/Es and bitcoin on the exact same day, December 18th, they have traded very closely together,” Wilson adds.

“While we do not expect this relationship to continue to hold so tightly we do think it will be hard for P/Es to move significantly higher or lower without a commensurate move in the digital currency.”

In other words, enthusiasm for the stock market as expressed by investors willing to pay a higher price for future earnings peaked just as the price of bitcoin peaked.

On Tuesday, bitcoin was trading just above $8,000 per coin, down from around $10,500 a month ago and more than 50% below its all-time high of just below $20,000 hit back in mid-December. The S&P 500 was up 0.1% after a 2.7% rally on Monday and is down 0.5% so far this year.

Bitcoin caused a craze in the second half of 2017, but it’s price might have become more useful for stock market investors in recent months, say analysts at Morgan Stanley.

And this jives with an observation from Wilson last week which posited that the rally seen in the stock market over the first few weeks of January was a “melt-up” that marked the top for investor sentiment this year. Because if 2017’s market rally appears in hindsight to have clearly hinged on investor anticipation of the benefits of tax reform, the realization of these benefits resulted in a flurry of bullish views on the market at the outset of the year that almost necessarily sets up investors for disappointment.

“In other words, by the time people are calling for a melt-up, it is basically over,” Wilson said in a March 19 note to clients. “Tax cuts were the event to capture investors’ imagination, but the reality is that the market had been pricing tax legislation in for months, if not quarters.”

And so in thinking about where stocks go from here — and three-straight days with the S&P 500 moving more than 2% certainly shows a market searching for direction — Wilson sees bitcoin as a key marker of investor sentiment and a potential guidepost for markets.

“More interestingly, Bitcoin has been leading on the downward moves by about a week or two,” Wilson writes.

“In fact, Bitcoin tested (successfully) it’s 200 day four days before the S&P 500. Therefore, we believe bitcoin bears watching.”

And as the chart from Wilson shows, the market’s recent move lower on a valuation basis overshot the earlier drop in bitcoin, potentially signaling that stocks will rebound to move back in line with the digital currency.

The stock market’s valuation and the price of bitcoin have had a close relationship in recent months, Morgan Stanley notes. (Source: Morgan Stanley)

Myles Udland is a writer at Yahoo Finance. Follow him on Twitter @MylesUdland

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