3 hot sectors, a handful of stock ideas, and what could come next

There have been three dominant sector winners in the last 12 months – AI, gold and defence. These should hardly come as a surprise.

There are queues down Martin Place to purchase bullion. Geopolitical risks have heightened and, on the back of a US push, most economies are stepping up their defence spending. And AI hardly needs an explanation as it continues its game-changing growth.

Conversely, it’s been a hard year for healthcare, which has been hit by the US tariff on pharmaceuticals, along with vaccine scepticism, and pricing pressures.

There’s also been plenty of good economic news out of the US to bolster markets – inflation appears steady, jobs numbers have held up for the most part, and the rate-cutting cycle is still underway to support consumer spending. The story has been mostly similar in Australia – even with a surprise jump in the last inflation print.

Markets have hit record highs. Repeatedly.

Only last week, the S&P500 reached 6,764.66 while the S&P/ASX 200 hit an all-time high of 9054.50 back in August. It wasn’t the first record for either index this year. Currently, both indices are up strongly for the year - circa 12% and 8% respectively.

In light of this, I spoke to three fund managers covering large, small and micro-caps:

• Damien Boey, Portfolio Strategist for WAM Leaders, Wilson Asset Management
• Gareth Brown, Portfolio Manager for Forager International Shares Fund, Forager Funds Management
• Joel Fleming, Portfolio Manager, Microcap Equities, Yarra Capital Management

They shared how they have invested, some of their stock winners of the last year, and how they are positioning going forward.

Market themes and activities over the past year

“There’s been three obvious themes this year. First, the gold price has been on an amazing run. Second, there’s been a change in thinking in terms of defence – and by extension, strategic minerals. Finally, AI remains an area of broad interest, when you consider performance and the huge amount of capital going into this space,” says Fleming.

These three themes have been significant drivers behind the top-performing sectors both domestically and globally – though, as Boey notes, “US technology outperformed its domestic counterparts due to the much broader AI exposure in the US.”

He cites two top performers in the US tech space as CoreWeave (NASDAQ: CRWV) and Applovin (NASDAQ: APP). Whether they can continue their strength “depends on finding revenue to cover AI capex, as well as the outlook for rates.”

Financials, materials and industrials were also strong performers in the last 12 months, while healthcare has underperformed, along with US materials (compared to Australian counterparts).

“Australian materials have been bolstered by heavy exposure to gold, while US materials have been weighed down by housing,” says Boey.

Small and micro-cap performance

Stepping through the market, there have been differences in performance based on market capitalisation.

Brown notes that the Russell 2000 Index, representing US small companies, outperformed the S&P 500, but small caps haven’t rallied as much in Europe, the UK or Japan.

It’s also worth highlighting that, outside of large and mid-cap companies, “the thematic is often less important than the company specific,” as Brown puts it.

He has used market sentiment and themes to his advantage when a company has strong fundamentals but its prices have been hit by pessimism. He has two examples of this within the Forager International Shares Fund portfolio.

The first is Comfort Systems (NYSE: FIX), a company that specialises in complex HVAC, plumbing, piping, and electrical systems for large commercial and industrial sites. The company halved in a few months due to the Trump tariffs, only to rise more than 150% in six months.

The second, which was also his biggest winner, was Nutex Health (NASDAQ: NUTX), a US small hospital operator that has increased more than tenfold since purchase in August 2024.

“It was a messy and deeply misunderstood situation where our analytical edge really paid off,” Brown says.

From a micro-cap perspective, easing rates have been supportive and Fleming has seen a strong reporting season, along with better valuations and growth. He anticipates we are heading into a positive environment for microcaps.

He is seeing increasing M&A activity, a sign of confidence, pointing to recent acquisitions by Eagers Automotive (ASX: APE) and Tuas (ASX: TUA) as examples.

Fleming doesn’t ignore market thematics but is thoughtful in how he incorporates them.

“In technology, for example, we invest where a company has a competitive advantage, growing markets, and they fulfil a specific need,” he says.

Exposure to AI might come from companies doing wiring for data centres and energy providers, like SKS Technologies (ASX: SKS) or Southern Cross Electrical (ASX: SXE), rather than seeking the next Nvidia. Some of the top performers in his space have included Droneshield (ASX: DRO), RPM Global (under takeover), Energy One (ASX: EOL) and DUG Technology (ASX: DUG).

Positioning for the next 12 months

AI, gold and defence are going nowhere. All three fund managers continue to hold exposures to these in their portfolios. 

Critical minerals have also been in focus, stemming from the broader AI trend. For example, Fleming highlights investments in MetalsX (ASX: MLX), Aurelia Metals (ASX: AMI) and Larvotto Resources (ASX: LRV) for exposure. 

Some additional focus areas referenced include resources, domestic property, healthcare, energy and even a regional opportunity in Japan.

Boey believes there is an opportunity coming in using alternative asset classes like commodities, and believes resources will outperform in the coming year.

“World growth is re-accelerating after the US government shutdown. China could chime in with stimulus. Global central banks are deliberately running rates below world nominal GDP growth, consistent with excess money supply growth in the world supporting scarce resources,” Boey says.

He is also watching the domestic property cycle and notes that in 2026, investors might revisit quality in staples and healthcare, “especially if there are disruptions to global financial plumbing”.

Brown notes that “today’s market is characterised by 'high dispersion' where some sectors and stocks are thriving while others are languishing.” Particular regions he has been focusing on are Europe, the UK and Japan, where small caps have rallied less.

“It’s where we’re finding the most compelling smaller-cap opportunities, and we’re increasingly leaning into those markets,” Brown says.

He believes the market is underestimating Japan at the moment. He explains that profound governance changes have led to significant improvements in the market there, which have been noticed by investors in larger-cap companies, but the investment hasn’t quite flowed down to the smaller end of the market yet. Japan is about 20% of the portfolio today.

He also points to digitisation as a major trend for Japanese investment – “parts of the Japanese economy remain surprisingly archaic. Much office work is still done on paper, and cashless payments run at about half the rate seen in Australia.”

“Many of the investments we hold in Japan today mirror playbooks we’ve seen in Western markets over the past decade—SaaS conversions, digitisation, cloud adoption, and more. These are themes we know well and believe can drive meaningful returns in the coming years,” Brown says.

From a microcap perspective, Fleming is positioned for structural growth stories – energy, for example, along with domestically aligned businesses.

“The Australian economy is looking good and we want to be exposed to companies that can be expected to get a bit of a pick-up as the economy improves, such as Baby Bunting (ASX: BBN) or Universal Store ASX: UNI) which caters to the younger demographic,” Fleming says.

He also sees the improving economy as a key driver, supported by a secondary prospective tailwind from the Olympics in Queensland, which will benefit PeopleIn (ASX: PPE) through labour hire.

Fleming is also positioned in the embattled healthcare sector. “We are all living longer, we need to effectively manage and have solutions for health concerns, which means long-term demand is always going to exist in this space.”

Some companies he likes include Artrya (ASX: AYA), which has had its coronary heart disease platform approved by the US FDA, and Dimerix (ASX: DXB), which is targeting kidney disease, but is an earlier-stage business.

Opportunities ahead

While there are always risks to watch in the market, each fund manager is positive on the opportunities ahead - with a caveat. Watch the quality and fundamentals. They're critical, whatever end of the market you are looking at.