Stock selection critical for Australian investors in 'twilight zone'

“Considerable evidence is mounting” that investors have entered a ‘twilight zone’ in March this year, according to Matthew Sherwood, Perpetual Investments’ senior manager investment markets research.

A ‘twilight zone’ is generally described as a period when share prices rise even though dividends are being cut and earnings are declining but rising share markets suggest that a more aggressive strategy could be appropriate.

Australian investors have experienced a ‘Twilight Zone’ episode every decade for the past 50 years, Sherwood said, lasting on average 18 months – with average price rises of 32 per cent, and earnings declines of 20 per cent.

He said that Australian equities have bounced harder in the past 12 weeks other than at that at the beginning of any other twilight zone since the 1970s

“Investors may be experiencing an unusual sensation at present as earnings are declining, a frustratingly tepid economic recovery is at least six months away, but all major share markets have rallied over 20 per cent since March.

However, he cautioned that stock selection is likely to be of critical importance to investors in the prevailing ‘twilight zone’ even though the market could drift higher.

Investors should be wary of companies with high debt, opaque business models or that have highly cyclical earnings in this environment, he said.

Conversely, he said a diversified portfolio of companies with strong cashed-up balance sheets, higher earnings certainty, sustainable dividend growth, dominant market positions and reasonable valuations.

“These companies should be able to withstand these murky times, irrespective of whether the ‘Twilight Zone’ lasts for a short period of time or considerably longer.””