How to Invest Domestically & Thrive Despite the Tough Australian Economy

High inflation, rising interest rates, falling house prices and high oil prices are hardly a promising sign for the Australian economy. Markets have priced in a further hike for this year following the latest Consumer Price Index (CPI), which rose 4% in the 12 months to August 2026, while trimmed mean inflation – the preferred measure of the RBA – remained at 3.6% (the same as in July). 

Beyond the obvious challenges for Australians keeping up with mortgage payments and grocery bills, a tougher economic climate can have implications for investing. Consider that a higher cost of borrowing via interest rates discourages business investment and growth, or that consumers with less disposable income will spend less on discretionary items, hitting the earnings of companies in this space. Falling property prices can further discourage developers and hit the pockets of businesses in and servicing the construction industry. 

Adding to the general concern, the 2026 Intergenerational Report painted a muted economic picture for the next 40 years. Think real GDP per person slowing to 1.2% (dependent on AI creating an increase in productivity) and significant challenges in servicing an ageing population via a shrinking workforce. 

For the average investor used to incorporating a generous allocation to domestic investments, this might feel like the time to jump ship. But there are still opportunities and ways to manage a tougher environment, and at the end of the day, remember that diversification remains finance’s only free lunch. 

Key Takeaways 

• The tougher inflation and rising interest rate environment can put pressure on Australian portfolios. 
• Ensuring diversification in a portfolio across sectors and asset types can help manage cycles. 
• Traditional defensive equity sectors include consumer staples, energy, utilities and healthcare, while telecommunications may be selectively useful. 
• Australian fixed income is offering higher yields to match rising rates, which can support income needs in an inflationary environment. 
• Commodities like gold can also act as an inflation hedge in a portfolio. 

Looking to the past and back to the future 

The current situation in Australia is often compared to the stagflationary period in the 1970s, also linked to an oil crisis (spurred by the Arab-Israeli War in 1973). In this period, energy was an obvious winner, along with commodities and precious metals, and real estate investment trusts also benefited. 

There may be some similarities and lessons from the past, but Australia’s inflation problem surfaced before the oil shock at the start of this year. Property has also been less of a buffer this time around, with legislative change and rising interest rates hitting the market and creating recent price falls. 

Substantial investment in AI development and infrastructure has been supporting global markets over the last year, and it forms part of an ongoing theme. There is some indication that it isn’t helping with the inflation problem. 

Much of the AI spend is committed and will continue to drive activity in coming years, though there are increased concerns over company valuations. The failed IPO of Firmus on the Australian market is a recent example. 

Industries that are alternative pathways to AI may be beneficiaries, despite the tougher market environment. For example, Australian copper and rare earths may benefit from increased demand to fulfil AI needs, or utility companies focused on water, power or machinery may service data centres. These are options for Australians to consider, given that Australia has a much smaller technology space. 

Winners & losers in a tough economy 

Turning back broadly to the market, the general rule of thumb in tough economic times is to look towards essential sectors and away from more optional spending. 

Think consumer staples, energy, infrastructure/utilities and healthcare as a starting point, rather than consumer discretionary or technology. People will trade down where possible, but the last things to go are usually basic groceries and the energy bill. 

Telecommunications is a more recent essential – can you manage daily life without a mobile phone? 

However, this sector should be considered with caution, as there’s plenty of competition on rates and consumers may look to switch providers or reduce their packages in tough times. Telecommunications providers in Australia are also currently facing large costs to upgrade their infrastructure (including for AI). 

The energy sector is currently benefiting from supply challenges, partly from the US-Iran conflict putting pressure on oil and gas, and partly from sharply rising demand to fulfil AI power needs. 

Not all companies are benefiting equally from the challenges, so when investing in the energy space, it can be useful to consider either keeping it broad with an ETF focused across the sector or using active management from a specialist. 

Utilities and infrastructure may not always be front of mind for defensive investing – it’s worth remembering that utilities are often tied into long-term contracts and some are able to increase their prices in line with inflation, such as toll roads. These are often not the companies that will shoot the lights out, but they tend to be consistent in a portfolio and help smooth volatility. 

Don’t forget other asset classes 

Equities are not the only investment in town. When we talk about diversification, it’s also important to look at assets like bonds, commodities, alternative assets, property and cash. 

Inflation and rising rates can hurt the value of fixed income assets – but on the flip side, they can mean higher yields to support income in a tougher environment. 

Australian government bonds in particular are considered high quality and are paying strong yields off the back of higher interest rates, but higher-rated corporate bonds are also attracting investor interest. Calastone fund flow data noted increased inflows to Australian fixed interest in the first half of 2026. 

Private credit can similarly benefit from a rising rate environment, but investors should consider concerns like real estate concentration risks, liquidity, valuations and governance before selecting fund managers to use in this space. 

Selected commodities can also benefit in an inflationary environment. For example, gold has traditionally been treated as a hedge against inflation in a portfolio. Gold prices did experience an adjustment in the earlier part of 2026, but the World Gold Council predicts that prices can continue to grow and that central bank buying activity remains a supporter of prices. 

The key to investing in Australia 

While times are tougher, Australia remains a valuable part of an Australian investor’s portfolio (and not just for franked dividends from equities). 

The key is diversification and ensuring you have allocations to defensive sectors and assets that can offer you a buffer against volatility and consistent returns from yield to sustain your income levels. It’s also critical to consider fundamentals – active management can be useful in these periods if you need a more selective approach. 

Remember, it’s not about making wide changes to your portfolio, but about ensuring your portfolio meets your strategy, is adequately diversified to manage market cycles and keeps solid fundamentals in mind. Some investors may also consider tilts to more defensive assets to bolster yield and counter inflation in these periods, while keeping the core of their portfolio stable. 

Frequently Asked Questions 

How should you position your portfolio in tougher economic conditions? 

In tougher economic periods, diversification and sticking to your strategy tend to help you manage cycles. Incorporating allocations to defensive sectors and assets can help offer a buffer from volatility, but this should form part of your overall strategy. 

Which sectors tend to do better in inflationary periods? 

In inflationary periods, sectors that typically do better form part of essential needs and services, such as consumer staples, energy, utilities and healthcare. Telecommunications can also be considered an essential, though investors should monitor this. 

Which sectors tend to underperform in inflationary periods? 

Those sectors considered less essential, such as consumer discretionary, tend to underperform as investors trade their costs down and manage expenses. 

Should investors shift out of Australian investments in tougher economic periods? 

A diversified portfolio for Australian investors will include domestic investments, and there can also be tax benefits to continuing this approach, such as franking credits. A tougher economic environment doesn’t necessarily mean Australian investments don’t still offer solid fundamentals or support strategic needs. For example, Australian fixed income is currently offering high-quality yield, which is appealing to many income-focused investors.

Disclaimer: This article is prepared by Sara Allen. It is for educational purposes only. While all reasonable care has been taken by the author in the preparation of this information, the author and InvestmentMarkets (Aust) Pty. Ltd. as publisher take no responsibility for any actions taken based on information contained herein or for any errors or omissions within it. Interested parties should seek independent professional advice prior to acting on any information presented. Please note past performance is not a reliable indicator of future performance.