2025 Market wrap and outlook

Australian Shares

Australian shares produced a reasonable return of 10.3% but it wasn’t all smooth sailing with a major correction in March/April that led to a 16% drawdown in the market. The market correction was related to worries over US tariffs, which were subsequently delayed or toned down. The market soon recovered, boosted by an RBA easing cycle and a recovery in commodities.

Materials staged a major recovery in the second half of 2025 to be the best performing sector for the year with a total return of 36.2%. Small caps also recovered during the year with a total return of 25.0%. On the negative side, Healthcare continues to lag the market with a total return of -23.7%, while the technology sector also hit some major profit taking to end down 20.8%.

The local market currently trades on a FY26 P/E of 18.6x, with forecast EPS growth of 7.3%. The market seems fairly valued rather than overvalued but there are pockets (Banks) that do look expensive. We remain generally positive on the outlook for Australian equities with monetary and fiscal policy both supportive of the economy. The main risks are around inflation remaining above target (2.0-3.0%) which may force the RBA to lift interest rates.

Global Shares (unhedged)

Global shares (unhedged) returned 12.5%, while global shares (hedged) returned 18.7%. The AUD/USD rallied 5 cents over the year to US$0.67, which lowered unhedged returns. We also note that Global ex-US shares outperformed US shares with a total (unhedged) return of 22.9% vs 8.8%, respectively. US equities continue to perform reasonably well but Europe and Asia were generally viewed as better value and hence outperformed during the year.

The US market (74% of global market) hit some turbulence in March/April 2025 after President Trump announced his ‘Liberation Day’ tariffs. Subsequent trade agreements and roll back of tariff threats helped the market recover, while the technology theme also came to the fore. In addition, the US Federal Reserve (the Fed) resumed its easing cycle later in the year, which provided further support.

The US market currently trades on a 2026 P/E of 25.1x, with forecast EPS growth of 9.8%. The market does look fully valued, but we note that most of the large global technology stocks are listed on the US market and may deserve their high market valuations. In recent years, we recommended some currency hedging (to guard against a rally in the AUD) and to rebalance towards European and Asian markets (global ex-US) which paid off in 2025.

Global wrap

Global markets continued to be remarkably resilient during 2025, with growth assets (shares, property and infrastructure) posting another year of double-digit returns. Markets have faced numerous challenges over the past five years including: a global pandemic, rising inflation and interest rates, European and Middle East wars and more recently, US trade wars and a US government shutdown.

Support has come from easing monetary policy (in recent years) and fiscal policy remaining largely expansionary. In addition, major global megatrends – AI and reshoring supply chains and defence – have been positive for technology and commodities. The overall result is that global growth has remained steady at ~3.0% over the past 5 years.

But on the negative side, budget deficits and debt continue to expand in the developed world, with Germany the latest to embrace higher debt. Debt to GDP ratios are now above 100% in most developed economies and it seems that central banks are increasingly being pressured by governments to keep interest rates low and provide support for bond markets via quantitative easing (central banks buying government treasuries and bonds with money they create). This manipulation of interest rates could lead to inflationary consequences down the track via currency debasement. This is one of main reasons gold has gained 64% over the past year, along with a rise in geopolitical tensions.

As we enter 2026, monetary and fiscal policy remain supportive, but the easing cycle is nearing an end in most countries. We note that Japan is the first developed country to start hiking interest rates (albeit from a low base). The commodity rally has expanded from precious metals to industrial metals, and one wonders what this means for inflation down the track. The technology theme remains positive but there are lingering concerns over the return on investment that technology companies will eventually achieve on their massive capital expenditures. Overall, it seems that conditions remain positive in the short term, but the medium-to-long-term risks seem to be adding up.

Australian wrap

The Australian economy is growing around 2.0% and seems to be gaining momentum with private demand starting to recover. The RBA eased the cash rate to 3.6% during 2025 and the delayed effect of this stimulus should show up in 2026. In addition, commodity prices have staged a strong recovery since mid-2025.

On the negative side, inflation is currently running above target (headline 3.4%, core 3.2%) and means the RBA is at risk of raising rates in 2026. However, inflation figures are currently being impacted by temporary factors (the end of electricity subsidies and a new monthly inflation series from the ABS) and should subside during the year. The RBA is likely to be patient in the early part of the year, although the market does expect one rate hike by mid-year.

The sudden change in outlook for the cash rate has seen the yield curve rise, with the 10-year bond yield hitting 4.8% late in 2025. In turn this took some wind out of the sails of interest-rate-sensitive sectors like Financials, Retail, Property Infrastructure and Technology late in the year. In contrast, Materials have recovered strongly with commodity prices to be the leading sector (+36.2%) over 2025.

Turning to fiscal policy, government spending remains elevated with a budget deficit likely to persist in the medium term, although the level of the deficit (1-2% of GDP) and debt (40-50% of GDP) remain far lower than other developed economies. We note the Australia Federal government retains its AAA credit rating, while the Banking system is rated AA-.

In summary, the Australian economy remains solid and much closer to textbook than its larger peers in Europe, Japan and the US, which are all testing the limits regarding expansionary fiscal policy and central bank interventions in markets. However, the Australian economy does lack productivity and the level of innovation is lower than in the US.

Outlook

Markets have managed to climb ‘a wall or worry’ over 2025 that included US trade wars, a US government shutdown and a resurrection of inflation. The supporting factors seem to be expansionary US fiscal and monetary policy and the technology (AI) theme.

As we head into 2026, one wonders if inflation will start to become an issue for global central banks who seem to be allowing inflation to run above target. Maybe this is a deliberate ploy in times of high public debt (let’s inflate our way out of the problem!). But high inflation leads to rising costs for ‘main street’ and bond yields should also rise to compensate. Both are problematic for the government.

Overall, conditions remain positive for growth assets in the short term due to expansionary fiscal and monetary policy. Longer term, the risks seem to be rising around the unintended consequences of such policy (inflation, rising bond yields, currency debasement). There is also a risk that the AI investment boom fails to deliver a decent return on investment but that is also longer term in nature.