Why we’ve downgraded Australian equities but remain bullish on resources

Overview

The Australian market returned 1.3% for the three months and 2.7% for the year to 30 September. Resource sectors in both Energy (up 36.4%) and Materials (up 32.1%) led the way for the full year whilst the overall market was weighed down by weakness in Financials (down 0.5%), Consumer Discretionary (down 19.1%) and Health Care (down 10.7%).

S&P/ASX 200 Total Return Index (Sep-25 to Sep-26)

Outlook

Recommendation: Downgrade to underweight.

Until fundamentals improve or valuations become more compelling, an underweight position in Australian equities remains prudent.

The Australian market faces further interest rate hikes and increasingly restrictive housing lending policies. Higher borrowing costs are weighing on consumer spending, housing activity, and commercial real estate. While resources continue to benefit from resilient commodity demand and strong earnings, elevated valuations and weaker domestic demand leave the broader market vulnerable. On balance, we believe these risks outweigh the positives. Until fundamentals improve or valuations become more compelling, an underweight position in Australian equities remains prudent.

Sector view

The valuation backdrop shifted following FY26 reporting season.

The major banks continue to trade well above historical valuation levels despite limited growth prospects and increasing competitive pressures. By contrast, Real Estate has lagged amid expectations of further RBA tightening and is now the only major sector trading meaningfully below its long-term median valuation.

Overall, the market appears fully valued. Below average dividend yields and modest earnings growth expectations suggest constrained prospective returns.

S&P/ASX 200 Sector Forward Price-Earnings Ratios as at 30 September 2026

Banks

Recommendation: Remain underweight.

We continue to expect a gradual sector de-rating and believe an underweight position remains warranted.

Bank majors face the prospect of a slowing market for residential property lending in the near term. The FY27 Budget announcements curtailing negative gearing as well as raising capital gains taxes have curtailed sentiment for this asset class particularly amongst investors. Mortgage applications have slipped between 12% for ANZ[1] to as high as 20% for Westpac[2] following the Budget. As overall lending demand slows, competition for new mortgages is likely to intensify, placing further pressure on margins and profitability until investor confidence recovers.

Stronger business lending offers some support, with credit growth reaching 10.6% over the year to July, compared with 7.4% for housing credit. However, business lending remains vulnerable to a sharper economic slowdown if interest rates stay elevated.

Bank valuations remain extreme by historical standards. Australian banks have traditionally traded at a premium to international peers thanks to higher margins and robust growth, but both are increasingly difficult to justify. We continue to expect a gradual sector de-rating and believe an underweight position remains warranted.

Resources

Recommendation: Retain overweight.

Although resources valuations are not especially cheap, tight supply conditions and opportunities for earnings upgrades support a favourable outlook. We therefore retain our overweight position.

We remain optimistic on the commodities sector. Supply conditions are tight in key markets, most notably in copper. In addition, the demand backdrop remains positive. The buildout of data centres linked to the AI capital spending boom continues to expand and draw on copper and other key commodities. BHP notes that the data centre investment alone is expected to grow copper demand materially to over 3 million tons per annum (Mtpa) by 2050, a material portion of estimated global demand for 50Mtpa[3] by then.

The energy transition is another important demand driver, with renewable power, batteries and electric vehicles supporting growing lithium consumption.

Cumulative China battery production (GWh)

Industrial production also remains supportive of resilient commodity demand, increasing 3.4% over the year to June. Trade volumes have also remained robust, although recent strength may be somewhat overstated by volatility in tariff policies and the resulting pull-forward of trade activity.

Global industrial production and trade volume growth (Jun-16 to Jun-26)

Additional Chinese stimulus and stronger Indian steel production could support iron ore demand. We do not expect a material decline in prices, with market conditions remaining broadly balanced.

Although resources valuations are not especially cheap, tight supply conditions and opportunities for earnings upgrades support a favourable outlook. We therefore retain our overweight position.

Retail

Recommendation: Remain underweight.

With limited valuation support to offset these macro headwinds, we retain our underweight position in Consumer Discretionary.

Consumer discretionary names are facing a difficult backdrop as the impact of the RBA’s tightening cycle flow though to household cashflows. Early signs of pressure emerged during reporting season, with JB Hi-Fi (JBH) reporting weaker trading conditions across its Australian operations and a decline in same-store sales at the start of FY27. Sentiment was further dampened by Wesfarmers (WES), where Kmart delivered a softer-than-expected performance owing to currency headwinds and moderating sales growth entering FY27.

The CommBank Household Spending Insights Index rose just 0.1% in August, while household goods spending fell 0.3%, providing further evidence of slowing momentum.

Household spending indicators (annual % change)

While a still-resilient labour market and population growth provide some support to consumption, we expect higher mortgage costs and the negative wealth effects associated with the housing downturn to increasingly weigh on discretionary expenditure. With limited valuation support to offset these macro headwinds, we retain our underweight position in Consumer Discretionary.

Australian Real Estate Investment Trusts (AREITs)

Recommendation: Remain neutral.

While we are seeing valuation support and resilient underlying performance, we cannot ignore the economic reality and retain neutral positioning as a result.

The property sector has broadly stabilised following the sharp repricing in 2022–2023, with recovering transaction activity and improving valuations. It remains one of the few areas of the Australian market trading meaningfully below its long-term valuation average.

Australian real estate sector capitalisation rates (Aug-16 to Aug-26)

Operational performance remains robust, particularly among industrial and retail property names. Goodman Group (GMG) reported FY26 operating income growth exceeding 17%, supported by an expanding development pipeline. Work-in-progress projects increased 37% to $19.7 billion, largely driven by data centre developments. This should support strong earnings growth over the medium term.

However, four interest rate hikes in 2026 and the possibility of further tightening present ongoing challenges. Higher funding costs, constrained rental growth and more attractive cash and fixed-income yields may weigh on property valuations.

Accordingly, while we are seeing valuation support and resilient underlying performance, we cannot ignore the economic reality and retain neutral positioning as a result.