Mad Money

Cramer: Why the S&P is about to roar even higher

Trader on the floor of the New York Stock Exchange.
Brendan McDermid | Reuters

After a brutal week on the averages with the losing 2.8 percent in five straight sessions due to fears of China and the Fed, Jim Cramer was happy that the market finally had a rebound on Tuesday.

"That's why I think it is so important for us to ask ourselves whether the pain has already been baked in," the "Mad Money" host said.

To find out, Cramer turned to Mark Sebastian, a technician and founder of and colleague at Sebastian is also the "Mad Money" resident expert of the CBOE Volatility Index, also known as the VIX or fear index, because it is widely used to gauge the level of terror in the market.

Right now, despite the vicious declines in the past week, the VIX remains at remarkably low levels, dropping below 14 on Tuesday—which suggested to Sebastian that the market might be in better shape than you'd think.

When Sebastian sees this kind of pattern it can only mean one thing—the market is getting ready to roar again.

Looking at two charts of the S&P 500 and the VIX, Sebastian pointed out that we were in the height of the Greek crisis about three weeks ago, when there was also the first major selloff in China, when the VIX briefly skyrocketed above 20.

Immediately following the Greece-related spike, the VIX dropped dramatically and had its lowest close of the year.

But what was most interesting to Sebastian about this was that while the VIX hit a new low, the S&P did not hit a new all-time high. Usually when the S&P goes up, the VIX should go down and vice versa.

Sebastian saw the same pattern after the Chinese stock market crash recently, as the VIX was still well below where it was before the Greek referendum. Meaning, there is less fear now about China than when investors were freaking out about Europe.

When Sebastian sees this kind of pattern it can only mean one thing—the market is getting ready to roar again.

Read more from Mad Money with Jim Cramer
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Sure enough, there was a nice rally on Tuesday and Sebastian wouldn't be surprised if it goes even higher. In fact, he thinks the S&P could soar to new all-time highs, with the VIX falling back to 11. (Tweet This)

"I have to tell you, if the Fed decides to be logical at tomorrow's meeting and once again pushes off raising interest rates until a later date because of the situation in China, then Sebastian might turn out to be very right," Cramer added.

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