Three ways Australian equities could outperform global markets – but Zenith isn’t betting on them yet

Damien Hennessy

A rollover in the artificial intelligence (AI) trade, an interest rate pivot by the Reserve Bank of Australia (RBA) and a sustained rise in commodity prices are the three catalysts that could see Australian equities start to outperform global markets, Damien Hennessy, investment director and head of asset allocation at Zenith Investment Partners says.

While Hennessy doesn’t believe these catalysts are imminent, he says there is a chance they could come into play in 2027.

The first is that a reversal in the AI theme could lead an Australian rally. Hennessy estimates just 5 to 10 per cent of the Australian market is AI-related, which would leave local shares relatively insulated if the trade unwinds.

“The obvious catalyst would be that the AI theme rolls over and Australia becomes a place for investors to hide given it doesn’t have a large exposure to AI, aside from copper at the margins, compared to the US and emerging markets which is closer to 30 to 45 per cent exposed,” Hennessy says.

“If you’re still positive on that theme, global continues to be attractive. But if you’re wanting to diversify that risk, then Australia could be one of those markets where you can find diversification.”

The second catalyst is a shift in local monetary policy.

“The second potential driver of Australian equity outperformance would be an RBA pivot, and although I think it’s a little bit early for that, it may come in 2027,” Hennessy says.

“Historically, when the RBA cuts rates, it starts to provide support for the mid cap and small cap parts of the market, as long as you’re not cutting into a recession.”

The third catalyst is the resources sector.

“Australia has a 25 to 30 per cent exposure to materials and energy. If the market came to a view that resource prices and commodities were going to continue to rise, then Australia could benefit,” Hennessy says.

However, Hennessy doesn’t see any of these outcomes on the near-term horizon, and Zenith remains overweight global equities relative to domestic.

“There are three catalysts for a change, but I don’t see any of those on the near-term horizon. We’re still overweight global equities relative to domestic. That’s been a decision that we’ve had the last 18 months to two years,” Hennessy says.

Zenith maintains a constructive view on equities, though Hennessy says this depends on the AI theme delivering on earnings over the next one to three years. He also warns the lift in bond yields is effectively a tightening of financial conditions.

With bond yields above 5 per cent, Hennessy says bonds have moved into the fair value range after providing little return over the past five years.

“Bonds are not extremely cheap, but they’re no longer expensive. So that’s a positive for investors trying to construct portfolios,” Hennessy says.

“Investors are now getting 5 to 5.5 per cent for holding bonds, which means equities have to provide returns of 8 to 9 per cent for investors to be happy to hold that extra risk.

“We think the equity risk premium is now about 3.5 per cent in the case of the US. Equities do look expensive, but still attractive enough if you believe the earnings expectations that are built in.

“Over probably the last month, we’ve seen a number of more highly indebted issuers of debt or equities starting to come under pressure. So, I think there’s a bit of a move towards quality, and that’s not unusual at this stage of the cycle.

“The market is becoming a lot more discerning about quality and certainty over revenue streams and balance sheets.”