2025 Review and Outlook for 2026

Investor Letter – Calendar Year 2025 Review and Outlook for 2026

Australian equities delivered a volatile and increasingly selective performance over calendar 2025. While the ASX 200 reached record highs in mid-October—supported by resilient corporate balance sheets, easing financial conditions through much of the year, and recovery in selected cyclical and defensive earnings—this headline performance masked heightened volatility beneath the surface.

Markets experienced a sharp drawdown in April following the US announcement of new tariffs, while concerns around elevated valuations and inflation persistence resurfaced late in the year, prompting a reassessment of the interest-rate outlook. As a result, market gains were uneven, with returns increasingly driven by a narrowing group of sectors as valuations expanded and macroeconomic conditions became more contested toward year end.

Key Market Themes in 2025

Three dominant themes shaped equity performance during the year.

Interest-rate expectations were a critical driver. Early-year optimism around rate cuts underpinned a broad re-rating of equities, particularly interest-sensitive sectors such as Financials, Property and Technology. However, as inflation proved more persistent later in the year, expectations for further easing were pushed out. This triggered valuation compression, most notably across the banking sector.

Earnings dispersion widened materially. While aggregate ASX earnings growth remained modest for much of the year, several sectors began to stabilise or recover following a prolonged downgrade cycle. Healthcare earnings troughed, supported by improving hospital utilisation and cost control, while Materials benefited from stronger commodity pricing—particularly gold—and improving forward earnings expectations into FY26.

Structural investment themes gained increased prominence, particularly those linked to energy, electrification and AI-driven infrastructure. Investor attention increasingly shifted toward companies positioned to benefit from rising power demand, grid investment and energy security, reinforcing medium-term support for selected resource, energy and utility exposures.

Sector Performance

Financials were among the strongest contributors earlier in the year, supported by benign credit conditions, strong capital positions and declining funding costs. However, performance reversed sharply in the second half as valuations reached historical extremes. Commonwealth Bank, for example, peaked near 30x earnings before de-rating to below 25x by late November. Across the major banks, the average P/E multiple declined from above 20x to approximately 18.8x. A renewed upside surprise in inflation has raised the prospect that interest-rate cuts may be delayed, and this combination of elevated valuations and a less accommodative rate outlook has weighed on sector performance.

Technology and consumer-related stocks followed a similar trajectory. These sectors benefited from declining bond yields and improved risk appetite in the first half of 2025 but became increasingly volatile as concerns around valuation sustainability and interest-rate sensitivity re-emerged later in the year.

Healthcare has faced a particularly challenging post-pandemic recovery, with elevated labour costs—most notably nursing—and a delayed normalisation in patient volumes. More recently, selected pharmaceutical companies have also been impacted by tariff-related uncertainty in the US. However, discussions with industry participants, combined with the significant valuation discounts across the sector, suggest that current pricing does not adequately reflect healthcare’s long-term growth trajectory. Demand for healthcare services remains structurally strong, underpinned by demographics and rising chronic disease prevalence. Importantly, following their FY25 results in August, both CSL and Ramsay Health Care articulated clear operational priorities and return-focused objectives. Stabilisation in CSL’s earnings outlook and improving operating trends at Ramsay supported the first signs of a recovery in investor sentiment. This renewed emphasis on execution and return generation is an essential foundation for sustained sector recovery.

Materials delivered improving momentum as the year progressed, underpinned by resilient gold prices and a recovery across several key commodities. This strength contributed to a meaningful uplift in ASX 200 earnings expectations for FY26, now approaching ~8%, following several years of declining aggregate earnings. This represents a welcome inflection after three consecutive years of earnings contraction at the index level.

ASX earnings momentum supported by upgrades to resources

Valuations in Context

Equity valuations expanded meaningfully during 2025. The ASX 200 began the year trading at approximately 18x earnings, peaked near 20x in October, and moderated toward ~18.4x by year end. While this pullback has reduced some near-term valuation risk, market multiples remain elevated relative to history. The ASX 200’s 10-year average P/E is approximately 16x, with a long-term average closer to 15x. Dividend yields remain compressed at around ~3.4%, well below the long-term average of ~4.3%.

ASX 200 12- month forward P/E and Dividend Yield

Source: Refinitiv, MST Marquee

Momentum and Market Cycles

Momentum has been a defining feature of recent market cycles and has been particularly powerful in the current environment, driving valuations to levels rarely seen in nearly four decades. Importantly, this momentum has been concentrated in a relatively narrow group of stocks.

History suggests that such momentum-driven rallies eventually give way either to a broadening of market leadership—where opportunities emerge in undervalued sectors—or to a period of consolidation as valuations are reassessed against more realistic earnings expectations. As a result, future returns are increasingly likely to be driven by earnings growth rather than further multiple expansion.

Portfolio Positioning

Portfolio positioning continues to emphasise earnings visibility, balance-sheet strength and exposure to durable structural growth themes.

ASX 200 consensus earnings have trended higher through November, driven by a meaningful uplift in earnings revisions for the Materials sector following stronger commodity prices. This marks a substantial reversal after three years of progressive earnings downgrades. Earnings growth for commodity producers is now expected to be approximately +14% in FY26, with upgrades adding an estimated $4.5 billion to ASX 200 profits, led by the iron-ore majors (BHP, Rio Tinto) and the gold sector.

Reflecting this improved earnings backdrop, portfolios maintain an overweight exposure to Materials of approximately 20%. The recent addition of South32 complements existing holdings, including BHP Group, BlueScope Steel, Northern Star Resources and Orica, providing diversified exposure across bulk commodities, energy transition metals and gold.

At the broader market level, expected ASX 200 earnings growth for FY26 has increased from around +3% to approximately +8%, reinforcing the view that the next phase of returns is likely to be earnings driven.

Looking Ahead to 2026

Entering calendar 2026, the market backdrop is finely balanced. Elevated valuations leave equities sensitive to inflation outcomes and interest-rate developments, while slowing global growth presents near-term risks to earnings momentum. Encouragingly, consensus earnings expectations are beginning to improve from low levels, particularly in Materials and selected Industrials, while there are early signs of a recovery in healthcare. Structural investment cycles linked to energy transition, electrification and AI-driven infrastructure continue to shape global capital allocation and provide long-duration support for selectively positioned companies, notably in energy, resources and utility sectors.

We remain focused on businesses with strong balance sheets, sustainable cash flows and exposure to long-duration structural themes, including energy transition, electrification and healthcare. Market leadership is likely to broaden as earnings growth improves beyond a narrow group of high-valuation stocks, creating a more favourable backdrop for active stock selection. Maintaining portfolio resilience while positioning for an earnings-led recovery remains central to our investment approach.