The stock market has been on a tear since Donald Trump won the presidential election, with the index averages surging to record high after record high, Jim Cramer said during his Mad Money program's "Off the Charts" segment. But how long can the post-election rally last? When is it time to start worrying?
To get a handle on that, Cramer turned for insight to Mark Sebastian, founder of OptionPit.com and a colleague at RealMoney.com. One of Mark's specialties is gauging the relationship between the averages and the CBOE Volatility Index, or VIX for short. The VIX measures the level of volatility that traders are expecting in the near future and is often used as a proxy for just how afraid we are. It's especially helpful in times of euphoria, like we have now, because it helps take emotion out of our assessment of the market.
First, Sebastian looked at these paired charts, below, of the S&P 500 and the VIX over the last three months. According to Cramer, Sebastian pointed out that from the end of September through right before the election, the S&P 500 was very choppy, and during this period the VIX steadily moved higher, which is about what you'd expect.
Then, after Trump's surprise victory, the S&P 500 roared higher and the VIX cratered, which is normal. Sebastian points out thought that, over the last few days, the VIX has continued to fall as the market averages have climbed still higher. He said that's a clear sign that investors believe in this rally and could be far from finished.
Note, below, this pair of charts -- the VIX and the S&P 500 going back to the beginning of the year. We had a terrific sustained run from February through June, and during that period the VIX kept sinking. Aside from a brief, misguided selloff in June caused by rate hike fears, which sent the VIX soaring, the fear gauge kept going lower until it finally bottomed in August, right when the market was peaking. Then, from August through two weeks ago, the VIX kept climbing as the S&P meandered lower, and again that's how it's supposed to work.
Now, though, things have changed again and it seems like the market's entered a new era of good feelings (average rising and the VIX falling). Sebastian said that as long as the VIX keeps declining, this is a rally we can believe in. If, on the other hand, the VIX starts rising with the averages, it could signal that the market is about to change course. But for now that's not a concern.
Still, there's one more thing we need to consider here, this next pair of charts, below, shows the VIX and something known as the VVIX. Just as the regular VIX measures the volatility of the stock market, the VVIX measures the volatility of the volatility index itself.
Sebastian said that after the election the VIX actually dropped much faster than the VVIX. At first that suggested some big institutional money managers weren't buying into the stock market's run. But in the past week, the VVIX has dropped sharply, something Sebastian said confirms that the Trump rally has staying power. When the VIX is falling and the VVIX is below 95 -- it broke through that level last Monday and now it's in the low 80s -- the market tends to produce some stellar returns.
And that, Cramer said, is the situation we're in today, according to Sebastian.