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With the 2025-26 financial year ending and a new one beginning, this week’s Brief looks back at the year that was in financial markets.
FY2025-26 delivered another exceptional year for investors, with global equity markets returning more than 20%. More importantly, it marked the fourth consecutive year in which global equities delivered returns well above their long-run average. For markets, the critical lesson was that the global economy again proved more resilient to shocks than expected. Understanding why markets performed so strongly is important in assessing whether those returns are sustainable.
The dominant investment theme over FY2025-26 was artificial intelligence (AI). But the focus of markets shifted from the promise of future productivity gains to the sheer scale of investment required to achieve them. AI increasingly became an infrastructure story, with investors looking beyond the Mag 7 towards the semiconductors, data centres, electricity networks and physical infrastructure required to support the buildout. The theme remained remarkably concentrated, but investor attention shifted along the AI value chain. Its influence even extended geographically beyond the US, with markets such as Korea's KOSPI repricing significantly higher as investors sought exposure to the semiconductor supply chain underpinning the AI investment boom.
The AI buildout may be one of the most important reasons the global economy has proved more resilient than expected. Over the past two years, the global economy absorbed shocks that would once have derailed growth. New trade barriers disrupted established supply chains. Conflict in the Middle East threatened a critical artery of global energy supply. Inflation proved more persistent than many central banks anticipated. Yet trade was redirected, investment continued, and corporate earnings generally exceeded expectations. Much of that resilience has come from the enormous investment pipeline associated with AI, which has supported demand for semiconductors, data centres, electricity infrastructure and related capital expenditure.
Australia missed much of the AI-led global equity rally. The S&P/ASX 200 returned around 6% in FY2025-26. Australia's lower technology weighting meant it had limited exposure to parts of the AI value chain that attracted the strongest investor interest. Yet the influence of the theme was still evident through the materials sector, where demand linked to AI infrastructure, electrification and data-centre investment provided an important source of support.
Index composition was only part of the story. The Australian economy presented a challenging cyclical backdrop, with persistent inflation and higher interest rates weighing on earnings growth and valuations. The RBA responded to the domestic inflationary pressures by raising rates three times in the second half of the financial year, making Australia one of the few developed economies where monetary policy became more restrictive. Those conditions weighed particularly heavily on financials, a sector that occupies a much larger share of the Australian index than most global benchmarks.
Australia was initially viewed as a special case. Yet by year-end, aspects of the Australian experience were beginning to emerge in the US. Inflation remains above target, the labour market has proven resilient, and markets are starting to question whether policy settings are sufficiently restrictive. The environment confronting US investors at the start of FY2026-27 therefore bears a striking resemblance to the environment facing Australian investors at the start of FY2025-26.
This does not necessarily imply a weaker year ahead for US equities. The US market will continue to benefit from the AI buildout. But Australia’s experience does raise an important question. If higher inflation and tighter monetary policy contributed to Australia’s relative underperformance over the past year, could a similar set of forces eventually become a headwind for US markets?
Bond markets are starting to ask that very question. While equity investors celebrated resilience, bond investors focused on its implications. Australian and US 10-year government bond yields rose by 56 basis points and 24 basis points respectively over FY2025-26. Importantly, much of that increase reflected rising real yields rather than higher inflation compensation. The AI buildout sits at the centre of this story. Together with the energy transition and rising defence spending, it points to a world requiring substantially more investment than investors became accustomed to during the decade following the Global Financial Crisis. The result is a growing likelihood that equilibrium interest rates settle at a higher level than markets have historically assumed.
There is an important lesson for investors. The AI buildout that helped support both economic resilience and market returns over FY2025-26 is also increasing demand for capital. Alongside the energy transition and rising defence spending, it points to a world of structurally higher investment and higher real interest rates. After four consecutive years of above-average returns, the question for FY2026-27 is whether equity markets can continue to outperform as real interest rates rise. If Australia foreshadowed some of the challenges now emerging in the US, bond yields may prove a more important driver of future market returns than the economic shocks investors spent much of FY2025-26 worrying about.
