As the U.S. stock market continues to grind higher, even in the face of the Las Vegas mass shootings, Jim Cramer told his Mad Money viewers Tuesday that it's important to ask whether investors have become too complacent.
Sebastian took a close look at the classic measure of complacency in the markets, the CBOE Volatility Index, or VIX (VIX.X) for short.
The VIX is widely used as a proxy for the level of fear in the broader stock market, hence its nickname: the fear gauge. When investors are scared, the VIX shoots higher; when they feel confident, the VIX goes lower. The action in the VIX can provide insight into where stocks might be headed.
The key, according to Sebastian, is to not look at the VIX in isolation. The index has closed below 10 for a week straight. But that only tells you half of the score. For the other half, according to Sebastian, you need to look at the action in the broader market, as represented by the S&P 500.
Sebastian started with a chart of the volatility index in 2017. He noted that volatility fell sharply in September, which is highly unusual. August has tended to be the most volatile month for the market, followed by September and October. But while volatility did spike in August, it vanished in September despite nuclear brinksmanship with North Korea, political disarray in Washington and some significant hurricanes in the U.S.
But the lethargy in the index has been present all year. Since the beginning of 2017, the VIX has only had one close above 16. By comparison, the VIX's long-term average is between 17 and 18. So, even when the fear gauge screamed higher in August, it was still spiking to a below-average level.
Sebastian also notes that the VIX has had an unusual number of low closes. Since VIX futures became tradeable in 2004 the index has closed below 10 only 36 times, and only 8 of the single-digit closes happened before 2017. In some ways, according to Cramer, it's almost as though the market has forgotten how to feel fear.
In two additional charts, Sebastian compared the VIX's performance with the S&P 500. Even though the VIX is falling from low levels, stocks keep rising, as you'd expect with declining fear.
At the beginning of August, when Cramer last checked in with Sebastian, the VIX was rising with the market, a worrying sign. And indeed the S&P 500 did sell off shortly after that, at least for a little while.
Now, though, the situation is different. Even as the S&P 500 keeps going higher, the VIX keeps falling, as it's expected to do. Despite warnings from analysts and market bears of the pending bubble burst, Sebastian likes what he sees. Sebastian believes it will take something really unexpected and really negative to knock stocks off course. There are candidates for that, such as earnings coming in much worse than expected, or Congress muffing on tax reform. Sebastian thinks that if it implodes, that could do some real damage.
But even though Sebastian's feeling sanguine, it's certain that the current era of fearlessness won't last forever. And the last time the Volatility Index was this consistently low for this long was back in late 2006 and early 2007.
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