However, we know the external environment will always be unpredictable, and that over the medium to long term share prices will closely follow earnings growth.  

At AFIC, we remain focused on the fundamentals of buying companies with a strong management team, with a proven track record of successful capital allocation, and that are well-positioned to deliver strong earnings growth over the medium to long term. 

In AFIC’s view, there remain opportunities for investors in times of volatility willing to add some duration to their expectation for strong returns.  
 

Reflections on 2024 

The Australian equity market delivered a robust performance in 2024, driven primarily by three sectors: Information Technology, Real Estate, and Financials. 

Investors gravitated toward Information Technology companies, attracted by their perceived earnings growth, which led to higher valuations. 

Australian Real Estate Investment Trusts (A-REITs) benefitted from expectations that interest rates had peaked, creating a more supportive environment for property valuations. 

Meanwhile, Financials, led by banks, saw significant share-price appreciation, materially outperforming the broader sharemarket. 

At the same time, sectors such as Supermarkets, Materials, Utilities, and Energy lagged in 2024. Supermarkets faced uncertainty tied to price inquiries, while materials and energy were hindered by slowing economic growth in major commodity-importing countries like China. 

However, in AFIC’s view, as we move into 2025, the outlook for these sectors becomes more complex. High valuations in Information Technology and Financials could limit the potential for continued outperformance. 

For A-REITs, uncertainty about the direction of interest rates might delay the recovery of real asset values. Banks are also trading at high valuations in a climate where earnings growth is expected to slow. This divergence in sectoral performance has left the broader market trading at levels around 18% above its 20-year average valuation, as the chart below shows, highlighting the challenges ahead [1].  

Chart 1: Average Price Earnings (PE) ratio for Australian shares

Source: FactSet - AFIC
 

Bull case for Australian equities in 2025 

The case for optimism rests on supportive government policies and a recovery in global economic conditions. Should governments implement initiatives focused on productivity and wage growth, and positive economic growth, corporate earnings could receive much-needed support. A more conducive policy environment may boost investor and business confidence. 

China’s economic trajectory remains critical to the outlook for Australian equities. Should China implement effective stimulus measures, domestic consumption could rise, boosting demand for Australian commodities, particularly benefitting the materials and energy sectors, which faced challenges in 2024. 

In AFIC’s view, the healthcare sector could have greater market focus in 2025. During COVID-19, healthcare companies faced reduced demand and significant wage pressures. But their margins might expand in 2025, offering potential investment opportunities. 

Additionally, as valuations in high-growth sectors like Information Technology stretch, capital might flow into sectors, such as Utilities and Resources, where cyclical recoveries could potentially unlock value. 

Moreover, the political landscape in 2025 could offer greater clarity. With a federal election due in Australia and the US election cycle now resolved, businesses and investors may gain a clearer view of future policies, encouraging long-term investment. 

If these factors align, 2025 could see a year of renewed growth driven by broader participation across undervalued sectors. 

Bear case for Australian equities in 2025 

Despite the growth potential, significant risks weigh on the sharemarket outlook. Elevated market valuations limit room for error, especially as revenue growth slows, and despite inflationary pressure slowing, persistent cost pressures challenge profit margins. 

AFIC anticipates greater challenges for Australian companies in achieving growth in the current environment. While companies have been successful in navigating the recent economic landscape, the rate of earnings growth across the whole market could slow from here.  

Commodity-linked sectors remain exposed to global risks. If China’s recovery remains weak, demand for resources may stay subdued, continuing to strain the materials and energy sectors. Broader economic concerns, such as trade tensions and rising government debt, could further constrain growth by increasing costs without corresponding improvements in output. 

The combination of high company valuations with ongoing uncertainty in the macroenvironment makes the market more sensitive to volatility. 

AFIC cannot, and does not, attempt to predict the macro environment, but we do know that with so many uncertainties - from interest rates to geopolitical tensions - investors face a complex and unpredictable environment. These persistent pressures underscore the need for caution and patience from investors as they navigate the complexities of 2025. 

Conclusion 

In AFIC’s view, the operating environment for Australian equities in 2025 is unpredictable and challenging, marked by high market valuations and slowing earnings growth.  

Focusing on quality businesses with sustainable competitive advantages, strong balance sheets and a proven track record of resilience remains key. Companies that can navigate uncertainty and adapt to evolving conditions are best positioned to deliver consistent returns over the medium to long term. 

While risks remain, opportunities can be found in undervalued sectors or businesses aligned with favourable long-term trends. A disciplined, long-term strategy focused on quality can help investors manage volatility and achieve sustainable growth in this unpredictable landscape. 

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[1] Source: Australian Foundation Investment Company, FactSet data.