Homegrown heroes: Do Aussie equities have further to run?

The Australian share market has continued to hit record highs this year, buoyed by US market optimism and a domestic economy that remains surprisingly resilient in the face of inflation and interest rate rises. So can the rally continue, and what’s the best way for investors to tap into it?

Australian shares have benefited significantly from the tailwinds of the US equity market rally this year, and investors are taking notice. The S&P/ASX200 Index has continued to hit record highs, generating a more than 20% 12-month total return for the year to 30 September 2024.¹

At the same time, broad Australian equities has remained the second most popular exposure across iShares’ local range this year (behind only broad US equities), taking in almost $840 million net flows year to date.²

And similar to our optimistic stance on the US market – you can read more on this in our Q4 outlook – we believe the future continues to look bright. While Australian GDP growth has slowed recently as successive RBA interest rate rises put a handbrake on the economy, we think current conditions should represent the ‘trough’ from a growth perspective.

RBA forecasts indicate Australian economic growth should increase to a modest level of around 1% by the end of 2024, and return to trend levels of around 2.5% by the end of 2025 (see chart below). This boost may be largely underwritten by government spending, which has helped to keep the economy afloat as private consumption softens in the face of interest rate rises.

Australian GDP Growth Forecasts, 2024-26

Heading into a federal election cycle at the beginning of 2025, and with key elections taking place in Queensland and Western Australia, we don’t expect government spending to slow down heading into next year.

This is why sticky inflation does remain a risk to the Australian economic outlook – arguably more so than in other developed market economies like the US, where central banks have shifted their focus to supporting the labour market and economic growth.

Minutes from the RBA’s September meeting, where the central bank held rates at 4.35%, suggested inflation remained too high to consider rate cuts just yet. The most recent slight decline in the unemployment rate to 4.1%, indicates the local labour market continues to be resilient, potentially presenting less of a concern to the RBA than inflation.

While it’s too early to know the definitive impact of the recent stimulus announcements in China, it’s likely that Australia will also be a net beneficiary of any boost to Chinese economic growth both from an export perspective and in terms of the federal budget bottom line.

Timing the market vs time in the market

For those looking to access the Australian market’s positive growth trajectory, index investing represents a powerful and efficient option. According to S&P Global data, almost 70% of actively managed Australian equity funds underperformed the S&P/ASX 200 Index on a three-year basis.³

On a 10-year basis the performance difference is even more stark, with more than 80% of managed funds underperforming the index.⁴ While active stock selection can certainly play a role in portfolios, tracking the S&P/ASX 200 may in fact be one of the best options for investors looking for simple, long-term exposure to local equity market growth.

Australian Equity Managed Funds - Underperformance Rate vs the ASX200

As Australia’s leading equity index, the ASX 200 attracts billions of dollars of associated trades per day from large institutions and professional investors.⁵ The companies included in the index represent 80% of Australian equity market capitalisation, making it a comprehensive indicator of the overall performance of local shares.⁶

The structure of the index also allows it to evolve over time to take note of market trends at each rebalance – such as in September 2024 when Guzman Y Gomez, the ASX's most profitable IPO in 3 years, was added to the ASX 200, and the index’s technology sector weighting also increased to 3%.⁷

While the ASX 200 is known for its skew towards banks and mining companies, other sectors have also grown over time. Healthcare now makes up almost 10% of the index through stocks such as CSL and ResMed, and consumer discretionary has a more than 7% weighting through names like Wesfarmers*.⁸

Income is another important factor for Australian equity investors to consider due to the tax advantages of the franking system. Index investors can utilise the benefits of franking credits as you would for individual share holdings - for example, if we assume an indicated dividend yield of 3.55% for the ASX 200, with 77% franked dividends, that should equate to a gross yield of 4.72% including franking credits.⁹

Australian equities at the core of your portfolio

A low-cost, diversified and primarily large cap Australian equities exposure through the S&P/ASX 200 Index tracking product may make an effective starting point or core exposure to build out your share portfolio. Through a single trade, investors can gain access to 200 domestic shares across 11 sectors, which typically offer solid growth over time.¹⁰

With Australian equities as a core building block of your portfolio, it’s possible to then add other strategic or tactical overlays. You may want to diversify into international markets or sectors that have a lower weighting in the Australian market, or add other more niche exposures depending on your investment views. As the macro picture in Australia begins to look more constructive, a broad market exposure may be worth considering as a component of an overall diversified equity portfolio.