With the Dow Jones average inching towards 22,000, even Jim Cramer found cause to wonder whether the stock market’s continuous rally is truly sustainable.
“We always need to ask ourselves if we’ve gotten too complacent. That’s just a necessity. You do that as part of being a disciplined investor,” the “Mad Money” host said.
And one of the surefire ways to check complacency in the market is with the CBOE Volatility Index, known as the VIX for short, Cramer said.
The VIX measures traders’ expected levels of volatility in the near future, and is widely known as the “fear index” because of its ability to gauge the amount of fear in the marketplace.
For a deeper analysis of the fear gauge, Cramer turned to the charts of technician Mark Sebastian, the founder of OptionPit.com, Cramer’s colleague at RealMoney.com and “Mad Money’s” resident VIX expert.
First, Cramer turned to a chart of both the VIX and the S&P 500 index. Usually, the VIX is supposed to go up when the S&P goes down and vice versa, hence its ability to track fear.
“When that behavior changes, it can mean something strange is happening,” Cramer said.
Since the start of 2017, the VIX has traded at historically low levels, spiking to its highest level of the year in April before dipping back below 10 in about a week. No other big spike in 2017 lasted more than one day.
Dipping below 10 is relatively unusual for the VIX and represents an unusual lack of fear, Cramer noted. Since 2000, the VIX has only done so 26 times, and 17 of those occurred after April 2017.
“That has Sebastian wondering why. Why the heck is the VIX staying so low? Is it really all about those traders shorting put options on the S&P 500, believing that things will go well forever? Sebastian believes that’s part of it, but he thinks there’s more to it than that,” the “Mad Money” host said.
Cramer pointed to the action in the S&P over the past four months. The index has seen very little volatility, steadily climbing higher with a 1 percent decline in May being the biggest drop.
Still, the VIX has been hovering around 10 since mid-July, seemingly unable to go lower despite the market’s slow, not-too-volatile grind higher. Sebastian also noticed the fear gauge making a pattern of higher highs and higher lows, which could mean the market is approaching a peak.
“Put it all together and Sebastian thinks we need to be prepared for a bit of a sell-off over the next few weeks. In the last couple weeks the VIX has managed to go higher along with the S&P, and that’s never a good sign. That’s what he’s focused on. However, this sell-off might be brief and minor, like the one we had in April,” Cramer said. “Bottom line: the volatility index, as interpreted by VIX master Mark Sebastian, suggests that this sedate bull market might be in a little more near-term danger than we’d like to believe. My view? Nobody ever got hurt taking a profit and I’d love a short-term pullback that you and I could use as a buying opportunity.”