JPMorgan Says ‘No’ to Crypto, ‘Yes’ to China

Cryptocurrencies are unlikely to become a popular asset for long-term investors, but Chinese equities and bonds should not be ignored.

Paul Yeung/Bloomberg

Paul Yeung/Bloomberg

As the global economy recovers from the Covid-19 pandemic, investments in secular trends such as cryptocurrency may seem appealing to investors who are interested in taking on more risk in their portfolios. But according to J.P. Morgan Asset Management’s annual Long-Term Capital Market Assumptions report, cryptocurrency, at least in its current state, is not a good asset for either retail or institutional portfolios, due to its volatility and lack of correlation with other assets.

The report, which was released on Monday, examined three potentially beneficial roles that cryptocurrencies (the authors specifically used Bitcoin, due to the amount of data available) might be expected to play in a portfolio: as diversifiers, as inflation hedges, or as growth assets — like tech stocks.

As a diversifier, the authors found that Bitcoin has not only demonstrated very unstable correlations with stocks and bonds, it has also not exhibited the characteristics of a safe haven asset such as gold. While it’s true that Bitcoin cannot be issued or controlled by any entity, institution or government — a characteristic that has allowed gold to serve as a safe haven during some periods of increased political or economic uncertainty — JPMAM’s analysis indicates that to this point, Bitcoin’s price has not mimicked gold’s and has in fact been far more volatile than gold or other traditional assets, including the U.S. dollar, the Japanese Yen, the S&P 500, and 10-year U.S. Treasuries.

“Relative to all of these assets, Bitcoin is literally a quantum leap higher in terms of volatility,” David Kelly, chief global strategist at JPMAM, said in a press conference on Monday. “It is extremely difficult to come up with any logical framework for forecasting returns into the future.”

Kelly noted that some investors may be attracted to the kind of volatility inherent with cryptocurrencies like Bitcoin, perhaps because they believe that if traditional assets go down, cryptocurrencies will go up. But he said that there’s no evidence of correlation either way. “If cryptocurrencies [zigged] when other assets [zagged], then maybe you [could] reduce portfolio volatility through cross correlations,” Kelly said. “Unfortunately, whether we look at it relative to U.S. equities or Treasuries, we are really just not seeing those correlations either way.”

As an inflation hedge, Bitcoin’s forced scarcity — a maximum of only 21 million bitcoins can ever be mined — may make it seem like an asset that offers at least some protection against inflation, but the report says that the numbers to this point don’t bear that out. Bitcoin has briefly acted like gold, most notably around the Federal Reserve’s announcement in March 2020 of its plans to support the economy during the pandemic. But it hasn’t exhibited the correlation with macro inflation expectations — such as the University of Michigan’s survey readings on inflation expectations and market breakeven rates — that investors seek from an effective inflation hedge.

The authors concede that the growing popularity of cryptocurrencies with traders and investors has created what some see as a correlation with growth assets such as tech stocks, but the report concludes that such correlations could simply be attributable to a quest for the “next big thing.” What’s even more important, they say, is that cryptocurrencies lack the equity ownership and control available with tech and other stocks.

For a portfolio with a 60-40 allocation, JPMAM found that given Bitcoin’s extreme volatility, an outsized annualized return of 33 percent — or 316 percent over five years — would be needed to maintain the portfolio’s volatility-adjusted return, or Sharpe ratio, and allow the investment to be considered an appropriate use of the risk budget. “We don’t think that, as currently constituted, [cryptocurrencies] are likely to represent a good thing to put in the portfolio of a long-term investor,” Kelly said.

‘An Optimistic Outlook’

On the other hand, JPMAM also looked at Chinese assets and concluded that it would be a mistake for investors to ignore them. China’s markets have become some of the largest in the global economy, and despite recent volatility due to new regulations, JPMAM predicted that Chinese equities and government bonds will remain strong additions to long-term investors’ portfolios.

“With investing in China, we see the rewards outweighing the risks,” Gabriela Santos, JPMAM’s global market strategist, said during the conference. “We believe [that] one of the big portfolio trends over the next decade is going to be the growth of Chinese onshore assets and global portfolios.”

JPMAM attributes the strong return, volatility, and correlation predictions to three key trends in Chinese markets: better access for foreign investors, a shifting investor mix, and a changing sector mix. “We continue to expect [that] rising participation of foreign investors in Chinese [markets will be] encouraged by the Chinese government,” Santon said. “It’s an optimistic outlook.”