Australia outlook: a bullish path over a wall of worry

By Michael McCarthy

The outlook for the Australian economy and sharemarket in 2026 is clouded by risk with clear streaks of opportunity. Momentum in asset prices remains positive, and despite significant threats to the domestic economy, the path of least resistance appears to be higher.

In 2025, the Australian sharemarket rallied more than 27% from its April low to its October peak. While more Australian investors are diversifying their portfolios with international shares, the broad move higher in the middle of last year served as a solid reminder there are rewarding local investment opportunities.

And we should see more of this in 2026. There is an emerging consensus that both the international and local outlook is warily optimistic. The sharemarket could well climb a ‘wall of worry’, with resource stocks acting as a likely swing factor that will heavily influence Australia’s overall market return.

Growth, Inflation, and the central bank

The Australian economy picked up momentum in the second half of 2025, setting up a stronger start to the new year. Many of the drivers of the economy are already in place. Gross domestic product growth accelerated in the third quarter, with the expansion of the economy passing 2% yearly. While this is still below long-run averages closer to 3%, it displays a pleasing upward trajectory.

Important leading indicators such as consumer sentiment, business investment, and capital expenditure rose over the year. The issue for the economy, and specifically for the Reserve Bank of Australia, is that inflation picked up alongside the growth rate.

Wages are currently rising faster than inflation, putting more upward pressure on prices. Headline inflation (3.8%) and core inflation (3.3%) are above target but are not setting off alarms at this stage. However, even at these lower levels, the persistence of higher inflation has analysts expecting the next move in Australian interest rates will be up. The danger is an inflationary spiral, as wage increases chase prices higher. A sharp move higher in inflation could see the RBA slam on the brakes with multiple hikes, tightening conditions and denting confidence.

Policy headaches for Aussie business

Domestically, the business environment faces policy-driven hurdles. In its first term, the current government capped gas markets, scapegoated supermarkets for food inflation, and re-introduced pattern bargaining for wages across industries. Energy markets remain distorted by ideological government intervention.

Additionally, legislated billions in wage rises to non-productive sectors, combined with huge levels of construction spending by state and federal governments, have caused materials and human bottlenecks. This contributes to an ongoing blowout in government debt, exacerbated by governments reporting operating surpluses while adding to debt through 'off-balance sheet investments'. Consequently, the business community has little confidence government will provide the right settings for sustainable business investment.

Three powerful international influences

The Australian economy’s relatively small size means that international developments are crucial to the local outlook. The three major world economies – the USA, China, and Europe – play a pivotal role in determining local trade and growth rates.

The United States is much less predictable. The unstated approach seems to be to 'juice' conditions using lower interest rates and easy money, formulating policy that encourages the broad economy to 'run hot'. While this strategy may result in terrific short-term growth, it runs huge risks of damaging economic infrastructure. Furthermore, ahead of the mid-term elections in November 2026, the potential for the Republican Party to lose control of one or both houses is real, increasing the risk of radical and populist policies. The US is the largest international swing factor for the Australian economy. It’s likely to remain largely inward looking, leaving it as a source of potential growth in trade for Australia, and of very substantial risks.

The base case for the People's Republic of China is an ongoing expansion of the economy at the rate of 5% per year. While there are domestic risks, such as uncertain employment conditions and the continuing adjustment in property markets, analysts' forecasts for exports in 2026 look modest. If trade relations remain calm, there is potential upside for Chinese economic growth. This is a probable positive influence on the Australian economy and resource stocks in particular.

The European Union is muddling along. German energy policy has slowed the prime engine of growth, and it is expected the European economy will increase by a little better than 1% in 2026. However, emerging inflationary pressures indicate the European Central Bank is at or near the end of its easing cycle. Any flare-up in the war in Ukraine would threaten EU prosperity, and contentious immigration issues continue to pose risks to political stability. Investment flows from Europe may have the largest economic impact in Australia.

The Australian dollar and currency markets

A reasonable growth outlook for the Australian economy, combined with support for important commodities, may see higher levels for the Australian dollar into 2026. Additionally, the RBA has signalled a tightening intention, while the US Federal Reserve is still loosening. Interest rate differentials are a clearly identified driver of currency markets, and, in this case, favour the Australian dollar.

This potential currency strength has implications for international investors. The prospect of a strengthening Aussie over 2026 could bring international support to the Australian sharemarket as global players seek to profit from a favourable currency view.

Risks to sharemarket performance in 2026

A base case for 2026 is that reasonable but subdued global growth lifts the market over the year. However, we must not lose sight of potential ‘black swan’ events that could derail the longest bull market in modern history.

• Perhaps the most obvious danger is an outbreak of inflation leading to rising interest rates. This would increase corporate borrowing costs, lower share valuations, and likely lead to a compression of price-earnings ratios.

• War, territorial conflicts, and trade disputes remain threats. Beyond the known conflicts in the Middle East and Ukraine, unexplored risks include energy fragility in nations that have set themselves on a renewables-only course.

• The sharemarket itself carries risk. As news flows, there is potential for surges of volatility and bubbles. While a sudden freezing of credit markets remains a concern.

Overall, volatility is expected to decline, but the intensity of volatility may increase, with periods of steady gains regularly punctured by bouts of panic.

One key strategy: core-and-satellite investing

Given this uncertainty, the core-and-satellite investment strategy could be an effective approach to 2026. This requires investing in a ‘core’ of stocks that benefit from base-case expectations, adding ‘satellite’ investments that may outperform if specific risks are realised.

Core plays: growth and stability

If economic growth and market momentum continue, leveraged exposures to growth could deliver the best returns. While many look to US tech stocks and the 'magnificent seven', there is a distinct trend of international investors rotating into globally significant, locally listed Australian stocks.

1. Resources for growth

In 2025, lithium and iron ore were overtaken by gold, silver, and copper as investor favourites, with all three hitting new records. A modest global growth outlook suggests they will play an important role again in 2026.

Australian investors are spoiled for choice with globally significant resource plays:

• Majors: Industrial commodity giants like BHP $BHP Group Ltd (BHP.US)$ and Rio Tinto $Rio Tinto Ltd (RIO.AU)$ , or specialist iron ore miner FMG $Fortescue Ltd (FMG.AU)$ , provide foundational exposure.

• Gold miners including globally significant Newmont $Newmont Corp (NEM.AU)$ and Northern Star $Northern Star Resources Ltd (NST.AU)$ offer direct access to world-leading listings.

• Copper remains key as the growth narrative switches from batteries to AI. Strength in major miners could spread to junior players if the outlook endures. Smaller players such as Capstone $Capstone Copper Corp (CSC.AU)$ and Sandfire $Sandfire Resources Ltd (SFR.AU)$ have significant appeal.

• Lithium stocks may receive further support as batteries remain central to the energy transition. Pilbara Minerals $PLS Group Ltd (PLS.AU)$ and Mineral Resources $Mineral Resources Ltd (MIN.AU)$ rallied hard in December 2025. Smaller players like Core Lithium $Core Lithium Ltd (CXO.AU)$ and Global Lithium Resources $Global Lithium Resources Ltd (GL1.AU)$ also recorded huge gains across the year.

2. Banks for income

Financial stocks are expected to grow in line with the broader economy.

• The big four may be good bets for those unsure about Australia’s economy. Their broad businesses and fully franked dividend yields appeal to 'buy and hold' investors.

• Macquarie Bank $Macquarie Bank (MBLPC.AU)$ is the exception to the rule. Its exposure to capital and commodity markets suggests it will thrive in a higher growth environment.

• But regional banks have less scale following the Suncorp $Suncorp Group Ltd (SUN.AU)$ exit, and insurers face ever-increasing claims.

3. Defensive retail

Supermarkets have unexciting growth prospects but offer defensive characteristics suitable for a volatile year.

• Coles Group’s $Coles Group Ltd (COL.AU)$ recent gains mean it may offer value opportunity over Woolworths $Woolworths Group Ltd (WOW.AU)$ .

• Metcash $Metcash Ltd (MTS.AU)$ remains undervalued but look for triggers to close its valuation gap.

4. Biotech bargains

Defensiveness is a product of share price as much as business model. As the global focus shifted to semiconductors, biotech companies were pushed out of the spotlight, creating value opportunities.

• CSL $CSL Ltd (CSL.AU)$ shares have fallen significantly, trading at a price-earnings ratio of around 20 times – an historic low.

• Cochlear $Cochlear Ltd (COH.AU)$ remains close to all-time highs.

• Telix Pharmaceuticals $Telix Pharmaceuticals Ltd (TLX.AU)$ and Ramsay Health $Ramsay Health Care Ltd (RHC.AU)$ have faced trouble, but their share prices are significantly off their peaks, offering defensive exposure to the demography thematic.

• Smaller biotechs such as Immutep $Immutep (IMMP.US)$ and Racura Oncology $Racura Oncology Ltd (RAC.AU)$ are seeking medical breakthroughs and may suit investors with higher risk appetites.

Risk plays: opportunistic advantages

Investors should consider satellite positions that act as a hedge against geopolitical conflict or energy policy failures.

1. Defence

Investors concerned about armed conflict might arm themselves with defence stocks.

• Shipbuilder Austal $Austal Ltd (ASB.AU)$ may offer strategic value even after soaring to highs in 2025.

• Droneshield $Droneshield Ltd (DRO.AU)$ is highly volatile but also holds appeal in the event of conflagration.

2. Rare earths

Rare earth miners are highly strategic in the event of globally significant conflict. Share prices were volatile in late 2025, making entry crucial.

• In late December, Lynas $Lynas Rare Earths Ltd (LYC.AU)$ and Arafura $Arafura Rare Earths Ltd (ARU.AU)$ were closer to recent lows than their highs.

• More speculative plays such as Ionic $Ionic Rare Earths Ltd (IXR.AU)$ and Heavy Rare Earths $Heavy Rare Earths Ltd (HRE.AU)$ are at the lower end of multi-year trading ranges.

3. Energy

Green hydrogen is struggling, hydro capacity is difficult to install, and battery technology is nowhere near the capacity required to firm renewable energy at scale.

• These hard numbers reveal that gas is the only viable answer in a carbon-constrained world. If the Australian government is forced to revise its energy plan in 2026, stocks such as Tamboran $Tamboran Resources Corp (TBN.AU)$ , Santos $Santos Ltd (STO.AU)$ , Beach $Beach Energy Ltd (BPT.AU)$ , and Amplitude Energy $Amplitude Energy Ltd (AELDA.AU)$ may benefit.

• While nuclear energy remains banned in Australia, local uranium miners may benefit from US data centres' huge demand for power. Investors might look at the locally listed NexGen (Canadian), larger local offerings such as Paladin $Paladin Energy Ltd (PDN.AU)$ and Deep Yellow $Deep Yellow Ltd (DYL.AU)$ , or Lotus $Lotus Resources Ltd (LOT.AU)$ and Elevate Uranium $Elevate Uranium Ltd (EL8.AU)$ for a mix of assets.

Final word: quality focus in a risk-heavy year

The year ahead is difficult to read, despite the sunny outlook as it begins. High levels of market-threatening risk mean investors should be prepared for anything. At some stage, the longest bull market in modern history will come to an end. Whether this occurs in 2026 is unknown.

Despite the risks, the Australian sharemarket may slog through again, recording an annual gain via a difficult path. While sector selection is vital, consistent characteristics in top-quality stocks – high return on equity, stable earnings, and low debt levels – will likely identify the winners of 2026.

This information is general in nature and has been prepared without considering your financial objectives, situation or needs. Consider the appropriateness of this information in light of your personal circumstances before making investment decisions.