- CNBC's Jim Cramer and volatility expert Mark Sebastian parse the charts of the market's fear gauge.
- Sebastian finds that investors may not get a better chance to buy stocks in 2018 than right now.
- Investors have become jaded enough that the market could finally bottom, Cramer says.
After inspecting the charts of the Cboe Volatility Index — a market measure sometimes referred to as the "fear gauge" or the VIX — volatility expert Mark Sebastian thinks that the market could soon exit its bearish phase.
Stocks have been trading choppily since early October, mainly on uncertainty surrounding the Trump administration's tariff policy and the Federal Reserve's plans for raising interest rates. The declines, led largely by shares of big-cap technology companies that reported earnings that Wall Street saw as underwhelming, have caused panic in the market.
But Sebastian, an expert in market panic, the founder of OptionPit.com and a colleague of CNBC's Jim Cramer at RealMoney.com, told Cramer on Tuesday that the VIX's charts suggest the worry among investors has subsided.
"[The] charts ... suggest that it's time to start doing some buying," Cramer said on "Mad Money." "[Sebastian] thinks you might not get another chance as good as this one for the rest of 2018. I don't know if he's right, but don't you find it heartening when you consider how right Sebastian's been in the past?"
In October, when stocks found some reprieve after a week of selling, Sebastian predicted that the pain wasn't over yet, noting that the VIX's peak doesn't always coincide with the market's real bottom. He was right, and the sell-off continued. It was only over when, three days later, the made its lowest low yet, but the VIX failed to make a higher high.
That trend is a cornerstone of Sebastian's theory about the market's current situation, Cramer said.
"Markets can indeed fall without the VIX rallying, albeit only for short periods of time," he explained.
The reason is actually quite simple, according to Sebastian. Based on past sell-offs, like the ones seen in this chart of the S&P and the VIX in 2018, investors eventually get jaded enough that they stop hedging against market swings. That leads them to stop buying S&P options, sending the VIX — which tracks S&P option prices to measure implied volatility — lower.
This chart shows the VIX spiking during the first sell-off of 2018 in February, then essentially brushing off the second leg down in March, Cramer noted. That pattern repeats itself on a smaller scale in October and November.
"The sell-off in October blindsided a lot of people. The sell-off in the last couple of weeks blindsided nobody. Even investors who thought we were ready to rally knew that there was another down-leg possibility," Cramer explained. "When the VIX and the S&P start behaving like this, Sebastian says it's almost always a sign that the stock market is actually trying to find a bottom."
Pairing that with the action of the Cboe VIX Volatility Index — a derivative of the VIX that has been dropping in recent days — Sebastian saw "an incredible sign" that a bottom may be at hand, the "Mad Money" host said.
When the VVIX is in free-fall, it means that money managers who bet on the action of the VIX itself think that volatility will go down, not up, Sebastian said. That means that the likelihood of dramatic market swings is, in their view, getting lower.
"Maybe the VIX is signalling that the Fed might be in one-and-wait mode — one rate hike and then wait and see — or that the president may actually have something positive up his sleeve when he has dinner with the Chinese president this weekend," Cramer said. "Stranger things have happened, and if they do, the bear might finally, at last, hibernate."
Stocks ended the day higher on renewed hope of a trade deal between the United States and China being made at this week's G-20 summit. The VIX ticked up slightly to just above 19.