Quarterly Newsletter Resources Shine as US and Australian Markets Face Valuation Concerns.

In the US, third quarter growth accelerated to 4.3% at an annualised pace from 3.8% in the second quarter. This was the fastest in two years. Consumption remained the primary driver, though its sustainability hinges on the labour market which seems to have stalled. The latest report on non-farm payrolls reduced the odds of near-term easing, but the economy remains fragile. Labour demand and supply have both weakened, with demand (companies hiring) playing the dominant role. It means further labour weakness could quickly revive expectations of further reductions in interest rates due to weaker consumption.

A good gauge of consumption comes from retail sales. Retail sales delivered a mixed signal however leading indicators of consumption like consumer confidence, point to slower spending ahead. Measures of consumer confidence declined throughout the fourth quarter after recovering from trade uncertainty earlier in 2025. On the prices front, headline and core inflation both came in below estimates, with headline inflation recording 2.7% over the year and core inflation recording 2.6% p.a. from 3.0% in September. Given data collection distortions due to the government shut down, however, this data series is of limited value. Inflation remains a lagging indicator and its leading components continue to point to a further (slow) reduction. Bond interest rates have remained stubbornly elevated due to growing government spending. The Congressional Budget Office expects both interest payments and debt levels to soar over the coming decades. In that light, the fiscal easing from the One Big Beautiful Bill Act and potentially, a Supreme Court decision to strike down the tariffs, may ultimately provide only limited economic benefit.

China: Property Market and Deflation

We have been writing for some time that China’s property market collapse has caused a deflationary pulse in the economy that continues to cause a headwind to economic growth. Although we saw an increase in inflation, the acceleration over the quarter was primarily attributable to rising food prices. Fresh vegetable and fresh fruit prices saw the largest month-on-month increases: +18.2% and +4.4% over the year respectively. Non-food inflation, on the other hand, remained unchanged at 0.8% over the year. Household appliance prices increased as a result of 2024's trade-in policy - a government policy to replace aging household appliances at a discount in an effort to bolster domestic consumption. The transportation and communication category continued to weigh on inflation over the year, primarily due to declines in transportation, fuel and communication appliances. China’s property market remains weak. House prices fell for 40th straight month in October. October’s 3.5% rate of decline was the fastest in a year.

The enigma between the weak property market and China’s circa. 5% GDP growth rate can be solved by looking at government spending. The economy is being pushed along by debt-fuelled public investment in areas such as manufacturing and infrastructure. The gap between the growth target and consumption is unsustainable however not imminent. The economy should slow if government spending slows and consumption does not increase. A number of rate cuts hasn’t helped and the consumption-focused stimulus that has been urged for years simply hasn’t emerged. A look at what is occurring from the sellers of goods is also revealing.

Producer price inflation (which tracks price changes from the seller's perspective) fell by -1.9% over the year to December. This level marked a 16-month high and the 39th consecutive month of producer price deflation. Despite expectations of a recovery, inflation remains relatively low and should not preclude further monetary easing in 2026. The stock market continues to perform well. However, the government’s ultimate goal was not merely to revive the market. It hoped the market would help revive the economy by building confidence through the wealth effect.

Australian Economy

The Australian 10-year bond yield increased to close the quarter at 4.80%, on the back of higher-than-expected inflation data, which took out the chances of any further reduction in interest rates. Coupled with a strong labour market, analysts are suggesting an increasingly likelihood that the next move in interest rates will be up. As we wrote in the last quarter’s report, we believed that the easing cycle was over. The quarterly inflation report, released at the time of writing, suggests price pressures are proving more persistent. Furthermore, the recent employment report was strong and the unemployment rate fell to 4.1% reflecting a tight labour market and by association stronger wage growth and elevated inflation.

The Westpac–Melbourne Institute Leading Index, which indicates the likely pace of economic activity in 3-9 months, was broadly consistent with 2025’s recovery carrying into 2026. However, the momentum is still not all that convincing with the Index growth rate only modestly above trend, having stalled through the middle of last year. An outright strong growth pulse, associated with the Leading Index growth rate recording over 1%, still looks to be a long way off. The mid-year budget update included a record revision of AUD 47.8 billion government spending forecasts, which calls into question the accuracy of the Treasurer’s budget papers and the quality of advice used by cabinet ministers to shape policy. The amount reflects what the government is expected to spend on the uptake of social support programs, such as home battery subsidies, as well as the impact of the student debt relief scheme.

STAR Portfolio Activity

Within the STAR Tactical portfolio, the investment committee remained invested in Gold, emerging market shares (IEM) and global small companies IXJ. These 3 asset classes performed extremely well for the portfolio. Gold’s investment case into 2026 remains supported by structural central bank (CB) demand and ongoing reserve diversification. Importantly, 2025 data shows that official sector purchases were strongest late in the year, with September, October and November each exceeding 40 tonnes, despite prices being materially higher. This suggests a return of price-insensitive demand rather than tactical buying.

We maintained the portfolio allocation in cash for the short-term reflecting our concerns that the US and Australian share markets are on the expensive side of fair value. Hence remained out of VAS and IOO.

Members understand that the share price increases we have witnessed in Australia and the US, have moved valuations above fair value in the short term. Whilst it was recognised that the AI investment theme, which has lifted share prices (particularly in the US), will continue for many years, the level of capital expenditure (money spent by businesses to make future profit) has been large. Profits need to rise to justify the return on the capital expenditure. If not the return on shareholder funds will drop and so could the share price. This heightened risk has prompted our reduced exposure. Indeed, this was the case with Microsoft’s results recently. Share market volatility has increased and more volatility is expected as we head into the US mid-term elections and geopolitical tensions increase.

The Committee rebalanced Gold down marginally in the Active portfolio as we believe it to be good practice to take profit in what appreciates and buy into lagging assets that become cheaper and/or better value. We also recognise that CBA, being 11% of the Australian share market index, remains expensive despite mining companies seemingly being better value. This began to reverse in January 2026 with US dollar weakness being positive for commodity prices and in turn the share prices of BHP, Fortescue and RIO Tinto.

The STAR Strategic portfolios were also rebalanced over the quarter generally reflecting a sale of growth assets including VAS and a purchase of fixed income and property assets.

Australian Share Market

The Australian share market closed 1.01% lower over the quarter to be 10.32% higher over the year. There was a solid move in the prices of resource companies over the year. The ASX300 Resources index finished the year 36.2% higher versus the ASX300 Industrial company index which ended only 4.1% higher. The Small Resources were 73% higher while small Industrial companies were 8.8%higher. The index of mid-sized resource companies increased by a very large 104.3% with this segment of the market’s counterpart - industrial companies just 5% higher over the year. The strength in resources was led by the gold mining companies which finished the year 127% higher with gold bullion 64.4% higher. The copper price was also strong, increasing 43.7% over the year. The rise in the prices of nickel, copper, cobalt and lithium saw the price of IGO Ltd rise by 65% over the quarter, while companies like Newmont Corp (17%), Evolution Mining (18%) and Pilbara Metals (79%) all performed strongly. Life 360 Inc (-37%) and Xero (-28%) performed poorly over the quarter as investors rotated out of more expensive technology companies and despite Life 360 increasing its profit guidance. The STAR Accelerated Australian shares portfolio outperformed the broader market over the quarter as the manager Joseph Palmer and Sons maintained the high cash holding with companies like BHP, Ansell and Flight Centre performing well for the portfolio. Iluka Resources performed poorly for the portfolio on profit taking following the 100% increase in the share price. There was only one portfolio change with an increase in the weight of AUB Group following news that private equity consortium EQT and CVC Capital Partners were walking away from their highly conditional $45 per share cash offer for the group.

International Shares

The Star Accelerated International shares portfolio underperformed the index by -3.83% over the quarter. The investment in QUAL which gives access the world's highest quality companies based on key fundamentals like high return on capital, profit stability and low financial leverage bounced back this quarter however it was not enough to defend the overall portfolio from the underperformance by Hyperion and Insync over the period. Within the Hyperion strategy, Palantir Technologies Inc., NVIDIA Corporation, and Axon Enterprise Inc saw the strongest share price performance, while RM Holdings, ServiceNow, Inc., and Costco Wholesale Corporation saw the largest declines. Long term performance is tracking to expectations of the Investment Committee with the manager backing its insights with high conviction exposures in the portfolio.

Despite producing a positive return, Insync underperformed the index over the quarter and the year. This was largely due to the manager’s underweight exposure to the “Magnificent 7” (NVIDIA, Amazon, Google, Tesla, Apple, Microsoft and Meta) based on the expensiveness of these companies. The top portfolio contributors included Alphabet, Tencent, Indra Sistemas – a European defence and security company, McKensson – a US healthcare company. Once again, the returns continue to highlight the unusually narrow leadership of the rally. Insync’s underweight position in NVIDIA was a detractor from performance. However, the manager owns alternative investments such as Alibaba.

Fixed Income

The Australian bond marked which has an average interest rate sensitivity of around 5 years declined by -1.15% over the quarter owing to the bad news on inflation. Corporate bonds with an interest rate sensitivity closer to 2.5 years declined by -0.47% whilst short-dated credit increased by 1%. Once again, Realm performed well over the quarter being the selected manager for short-dated credit. Portfolio activity was again characterised by a rotation out of Bank issued bonds and into asset backed bonds. Asset backed bonds also known as structured credit, became better value as they lagged the rally in bank bonds. The portfolio also added to its overweight position in corporate bonds and slightly increased its interest rate maturity by quarter’s end. This exposure has a higher credit quality (BBB+) than we expect to have over the long term, and is largely held in financials, mining, infrastructure and property related companies. Overall, the portfolio is conservatively postured and remains well diversified.

Outlook

The Australian and US share markets remain expensive overall but there are pockets of value suggesting that further market rotation is likely in the near term. The investment committee remains concerned that the meddling with the Federal Reserve coming from the Trump administration. This is problematic when viewed through the prism of rates being cut by too much following the recent reduction.

Geopolitical and political factors continue to fuel market volatility with little relief expected in the near term. President Trump’s recent actions on Venezuela, Greenland and (as mentioned) the Federal Reserve appear driven by 2026 being a midterm election year, and voter concerns about housing and the cost of living. Mr Trump’s sub 50% approval ratings are not critical and his unconventional behaviour aligns with his established political style rather than a loss of control. A shift toward more extreme actions, would likely require a sharper drop in his approval ratings or a major economic shock. If the party’s approval rating falls further or electoral defeat looms, more assertive foreign policy moves particularly involving Russia, Iran, Venezuela, and Cuba become more probable with oil markets most exposed.

Outside of geopolitical factors, the Treasury continues to issue a large amounts of short-term debt to fund the government deficit. This balance sheet expansion at a time of elevated inflation has seen commodity prices increase which will continue to favour the Australian share market, gold and silver. While high valuations are not necessarily a reason to be negative on share market performance over the coming year, they do make stocks fragile to shocks. We believe that our current allocation decision provides some buffer to these risks.

---

General Advice Warning

The information contained in this report has been provided as general advice only. The contents have been prepared without taking account of your personal objectives, financial situation or needs. Investment markets past performance are not necessarily indicative of future performance. Whilst Financial Advice Co Pty Ltd is of the view the contents of this report are based on information which is believed to be reliable, its accuracy and completeness are not guaranteed, and no warranty of accuracy or reliability is given or implied and no responsibility for any loss or damage arising in any way for any representation, act or omission is accepted by Financial Advice Co Pty Ltd.