What next for small caps

Defensive positioning has protected capital in a falling market

Markets have been volatile and eventful since the beginning of 2026. During March, headlines associated with the conflict in the Middle East dominated global equity markets delivering a sell-off as investors lowered risk and allocated capital to defensive exposures. However, markets have subsequently rallied following the announcement of a ceasefire and the start of peace negotiations between the US and Iran.

The outlook for the Australian equity market is less “bullish” than it was six months ago due primarily to the increase in local interest rates. The move higher is in response to rising inflation which risks being exacerbated by the increased energy costs associated with the conflict in the Middle East. Inflation continues to sit at 3.8 per cent, above the target range of 2 to 3 per cent. Higher rates are expected to slow household spending and consumer demand within the Australia economy and corporate earnings risk disappointing investor expectations. 

As a result, the portfolio has a more defensive structure compared to six months ago. Exposure to interest rate sensitive (property trusts, debt providers & banks) and consumer discretionary (retail) sectors have been lowered and companies with lower-risk capex exposed earnings growth (mining services, engineering contractors and data centres) have been prioritised.

We continue to believe that several key growth sectors are likely to support stock price performance and positioning within the portfolio.

Data centre construction growth

As a result of artificial intelligence and cloud infrastructure demand, data centres are now the fastest growing non-residential construction sector in Australia. A recent Macromonitor report estimates the value of data centre commencements increased by 52 per cent in the year to June 2025 and a further 10 per cent in forecast for 2025/26. Our analysis suggests that consensus is potentially underestimating the magnitude and speed of cloud and AI computing demand over the medium-term.  Industry estimates suggest that more than $50B to $60B of total data centre build cost will be required to meet demand over the next 5 years.

Forecast data centre construction demand is expected drive outperformance for construction/engineering and speciality service companies exposed to the sector. 

Defence Industry sector growth

A combination of geopolitical drivers, recent commitments to long-term government funding, and technological innovation have led to significant expenditure upgrades in the outlook for defence industry growth. Specifically, Federal government military expenditure is forecast to increase by $53B over the next 10 years. 

Within the domestic ASX listed universe, engineering, construction and infrastructure facilities management groups are well positioned to benefit from the forecast growth in defence sector expenditure. 

Brisbane Olympics / infrastructure investments

Construction plans for new and upgraded venues, accommodation and transport infrastructure associated with the Brisbane Olympics are expected to contribute to economic growth and construction sector demand within southeast Queensland between now and 2032. An estimated $7.0B is forecast to be invested in Olympic venue construction alone.  Ancillary investments are expected to lift the total expenditure meaningfully higher.

Listed building materials, civil construction and engineering groups are all expected to benefit from exposure to the forecast regional growth. Major construction contracts associated with the main stadium, aquatic centre, athletes’ village and several other regional competition venues are expected to be awarded in the next 12 months.