Q4 2017 Review: Will The Bull Market Continue?

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by: David Kotok

By Leo Chen, Ph.D.

With the Dow Jones Industrial Average approaching 25,000, the S&P 500 touching 2,700, and the tech-heavy Nasdaq Composite topping 7,000, our quantitative strategy has once again harvested considerable quarterly gains.

The US stock market is likely to have its second-best year since the financial crisis. While the Dow has touched a new all-time high one out of every four days this year, the Nasdaq is up almost 30% year to date. One $64-million-dollar question that every investor wonders about is, will the bull market continue next year?

Since the presidential election last year, over half of the S&P 500's sectors contributed to this one-year rally, with the Information Technology sector leading the way, miles ahead of others. Broadly speaking, 2017 can be seen as a marketwide rally. Among all the large-cap sectors, there is one particular phenomenon that is boosting investor confidence: sector rotation.

Dissecting 2017 into short segments, we observe that different sectors tend to lead the market at different times. Especially, two of the heavyweights, Financials and Technology, have alternated frequently this year, with joint force from Health Care and Consumer Discretionary. This pattern is typically deemed a healthy sign of broad market participation, particularly in a bull market like 2017's. It also marks a crucial difference between the current bull market run and the 1999 tech-bubble: Two decades ago, the market was led mainly by one sector.

Another major characteristic of this bull run is that volatility has remained significantly low. Twelve months ago, the VIX's sustaining below a 10 handle was not on anyone's forecast list for 2017. One of the main reasons explaining a low-VIX environment is that 2017 hasn't seen any major pullback: 3% is as much as the stock market has retreated in the past twelve months. However, while many may view VIX as a bargain at this time, we would like to remind investors that VIX is cheap only if it poised to rebound soon, as trading VIX exposes investors to significant risk.

So will the bull market continue into 2018? We will have to wait to find out in our 4Q2018 quarterly review. However, just as our quant model constantly monitors the market, we should always watch closely the important factors underlying a bull market.