Five arrows, five turning points: Where should investors aim next?

Australian shares are approaching some significant turning points. In fact, investors could be forgiven for not knowing where to aim.

But with five potential inflection points lining up, there may be plenty of opportunities to fire a few arrows and hit the bullseye.

Arrow One: AI 

Without dancing on the grave of the AI trade just yet, it's fair to say the mood is changing. And given how much AI has driven global markets, that matters for Australian investors too.

The first phase was pure exuberance. Explosive demand for AI models, grand promises of productivity gains and a mad rush to build data centres and processing capacity.

Now the pendulum is swinging towards doubt.

The big question is whether the frontier AI model builders, like OpenAI and Anthropic, can turn all this spending into a decent commercial return.

Switching between AI models is relatively easy, while cheaper open-weight models are proving good enough for many applications. That raises some uncomfortable questions about the eye-watering sums being invested, the debt funding it all and the somewhat circular nature of certain deals.

Here's the interesting bit. The first cracks didn't appear in share markets. They appeared in debt markets. The cost of insuring against some neocloud businesses going bust has risen, while lenders are demanding higher interest rates to compensate for the risk.

When the bond crowd starts getting nervous, it's worth paying attention. They tend to worry about getting their money back, rather than how much they might make.

Arrow Two: Bond Yields 

That brings us neatly to our second arrow: bond yields.

The AI boom has required a mountain of borrowed money. The AI thirst for capital has competed with governments for funding, while the investment spending itself has helped support economic growth, particularly in the US.

The combination has helped push bond yields higher.

But as doubts about AI returns on capex grow, bond yields in Australia and the US have started to roll over.

So where should investors aim their first two arrows?

For some time, value stocks have been running rings around growth stocks in Australia, helped by rising bond yields.

Value stocks generally trade on lower price-to-earnings multiples and often pay higher dividends. Growth stocks, on the other hand, rely more heavily on profits expected years down the track. When bond yields rise, those future profits become less valuable in today's dollars, and share prices can take a beating.

But if long-term bond yields keep falling, the tables could turn.

Some of the businesses most disrupted by AI are also ‘growth stocks’. As enthusiasm for the perceived AI winners fades and bond yields fall, investors may start looking again at the companies they've been avoiding.

Think software businesses like WiseTech and Xero, or online marketplaces like SEEK, CAR Group and REA Group.

Arrow Three: The RBA 

Our third arrow is aimed squarely at the Reserve Bank.

The RBA has been lifting interest rates in response to stubborn inflation, a stretched economy and higher energy prices. But there's a growing argument that the RBA may be nearing the end of its tightening cycle. Some would argue it has already gone too far.

House prices are weakening, consumer and business confidence remain soft, and unemployment is rising. Investors are already looking over the hill, trying to work out when the RBA might start cutting rates.

The economy tells you where we are. The share market tries to work out where we're going.

That's why shares can rally even when the economic news looks pretty ordinary. Markets don't wait for the good news to arrive. They start pricing it in beforehand.

If interest rates are approaching a peak, the next opportunity may lie in businesses that benefit from lower borrowing costs and an eventual economic recovery. Industrials, property trusts, utilities and infrastructure all come into the picture.

And eventually, consumer discretionary stocks.

Arrow Four: Housing 

Our fourth arrow comes with a warning: don't fire too early.

Australian housing is starting to look decidedly wobbly.

Forecasts for the peak-to-trough fall in house prices have been getting progressively worse, with some estimates now pointing to declines of 12% to 15%, and potentially more in certain segments.

When house prices fall, households tighten their belts. Throw in rising unemployment and a slowing economy, and consumers may have short arms and deep pockets for a while yet.

But once the housing market finds its feet, and interest rates start falling, the opportunity could be compelling. Businesses like JB Hi-Fi may eventually find themselves in the sweet spot of improving confidence, lower borrowing costs and consumers willing to open their wallets again.

Arrow Five: Diversification

Our fifth arrow is about something investors have become a little too comfortable with: concentration.

In both the US and Australia, the biggest returns have come from wading in a very small pool of stocks. In the US, it's been the AI spending crowd: Nvidia, the hyperscalers, and semiconductor companies.

In Australia, BHP has benefited from stronger copper prices, partly driven by AI related demand for power and infrastructure. Meanwhile the big banks have ridden the boom in house prices and mortgage lending.

Betting on a concentrated position to keep winning is a bit like sitting at the roulette table and continually doubling down on black. It can work beautifully for a while. But sooner or later the ball lands on red, and your night ends abruptly.

Diversification, on the other hand, is more like owning the casino. The house doesn't win every spin, but over time the odds are stacked in its favour.

With so many potential turning points ahead, spreading your arrows across more targets may be a much better strategy than continuing to fire at the same few names.

Ready, Aim… But Don't Fire Blindly

So there we have it. Five arrows, five potential turning points and plenty for investors to think about.

AI exuberance is giving way to doubt. Bond yields may have peaked. The RBA could be nearing the end of its tightening cycle. Housing has a speed wobble to navigate. And the era of a handful of stocks doing all the heavy lifting may be coming to an end.

Share markets reward investors who look ahead, rather than those who wait until the good news is obvious to everyone. So, sharpen those arrowheads, check the string on your bow is tight and start lining up your targets.

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