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As strong as Tuesday’s rally was, it may not mark the end of the sell-off that ravaged stocks in last week’s trading, CNBC’s Jim Cramer said.
Looking at the Cboe Volatility Index, also known as the market’s “fear gauge” or the VIX, Cramer and volatility expert Mark Sebastian determined that stocks could see another leg of pain even after Tuesday’s surge.
“While today’s up action looks fabulous, Sebastian points out that it doesn’t mean the pain is over,” the “Mad Money” host said. “Today, we’re melting up. Sebastian thinks that the volatility index has peaked for the moment, but as we saw in February and the summer of 2015, the day where the VIX peaks is not necessarily the day where the S&P 500 bottoms.”
Put simply, volatility refers to the amount of uncertainty in the market’s prediction of changes in a stock or index’s value. The VIX measures expectations of near-term volatility by tracking S&P 500 option prices.
When the VIX goes higher, it tends to mean that investors are getting more worried about the market and making bets to protect themselves.
Sebastian, the founder of OptionPit.com, Cramer’s colleague at RealMoney.com and “Mad Money’s” resident VIX expert, spotted a few similarities between last week’s sell-off and the weakness it endured in early February.
Back then, the VIX peaked before the S&P 500 truly bottomed, a sign that the VIX’s highest level doesn’t always coincide with the peak of the market’s panicked selling.
“This is one of the tells Sebastian watches for when he’s trying to call a bottom: […] if the market goes down and the VIX doesn’t spike to new highs, that’s the sign the pain might be over,” Cramer explained. “But the point here is that, at least in February, the peak in the VIX came before the S&P’s absolute bottom.”
“In short, when Sebastian looks at this market, he sees a lot of similarities with the February collapse,” the “Mad Money” host continued. “This is what February might’ve looked like [if] we hadn’t had all those crazy VIX instruments blowing up. And that’s why he predicts that the averages will test their lows sometime next week.”
The same thing happened in the summer of 2015, when the VIX surged to a notably high level of 40 one day before the S&P 500 actually bottomed.
When it did, the VIX dropped alongside the index rather than following its typical inverse pattern.
And “after yesterday, you can’t say we’re rebounding in a straight line,” Cramer noted. Stocks attempted a rally in Monday’s session before reversing course and ending the day lower.
“That’s why Sebastian believes there’s a strong chance that this market will retest last week’s lows, probably go lower, even,” Cramer continued. “He does not think we’ve seen the bottom.”
Once the market does bottom, though, Sebastian predicted a sustainable rebound that could even drive the S&P 500 to new all-time highs by the end of the year.
“But before that move can begin, he expects to see one more shakeout,” Cramer said.
“Bottom line? The charts, as interpreted by our resident VIX expert, Mark Sebastian, suggest that you may want to curb your enthusiasm at the moment,” the “Mad Money” host continued. “While today’s run was certainly encouraging, Sebastian says we need to have one more leg down before this market can actually bottom. My view? I don’t know. It makes some sense. I guess I just thought that today’s rally was a little more convincing.”