These are happy times for equity investors with the top 200 stock index rising again this morning and that's what is getting me worried.
The Australian market is on track to deliver its fifth straight session of gains as global volatility indicies are hovering around their lowest level this year.
While the Australian S&P/ASX 200 VIX Index (INDEXASX:XVI) is up over 4.7% to 12.98 this morning, it is still close to Friday's four-month low of 12.4.
It's a similar situation in the United States with the Volatility S&P 500 Index (INDEXCBOE:VIX,^VIX) tumbling to its lowest level since December 5 last year.
The lack of volatility may sound like a good omen for share markets because of the inverse correlation between the volatility index and market performance – meaning when volatility is low, equities outperform and vice-versa.
The problem is that volatility tends to have this annoying habit of reverting to the mean, and the last time the Australian and US volatility indices were trading at these lows, it marked the start of a market correction of between 5% and 7% that lasted a number of weeks.
If the volatility indicies do return to their 30-day average, it will likely coincide with another market sell-down.
I am expecting our share market to give back some of its recent gains in April or May as it has performed better than I was expecting since the start of the year with the S&P/ASX 200 Index (INDEXASX:XJO, ^XJO) delivering a 10% gain.
Many of our best performing stocks could take the brunt of a sell-off, and that means blue-chip stocks like Commonwealth Bank of Australia (ASX: CBA), hospital operator Ramsay Health Care Limited (ASX: RHC) and Domino's Pizza Enterprises Ltd. (ASX:DMP) could be targeted by profit-takers.
But these blue-chips won't be the only ones at risk. In fact, it is the mid-cap growth-stocks like disinfection device developer Nanosonics Ltd. (ASX: NAN) and agricultural chemical maker Nufarm Limited (ASX: NUF) that have been shooting the lights out over the past 13-weeks.
Active investors that are as fully-invested in equities as I am should be thinking of moving some cash out of the market – not to protect yourself from the market weakness per-se, but to give yourself some firepower to use the expected market correction as an opportunity to top-up on quality stocks.
As I have written before, equities are going to be one of the best performing asset classes in 2015 thanks to the softer Australian dollar, a potentially stimulatory federal budget and monetary policy.
