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Why Australia shares have stalled

Jack Atley | Bloomberg | Getty Images

Australia's economy has accelerated and its interest rates are at all-time lows, but its stock market hasn't gained any traction, with shares slipping to two-week lows this week.

"Even though the GDP (gross domestic product) number came in on the strong side, there's a lot of skepticism on whether that'll be sustained," said Shane Oliver, head of investment strategy at AMP Capital.

Australia's economy grew 3.5 percent on-year in the first quarter, its fastest pace in nearly two years, topping expectations from analysts in a Reuters poll for a 3.3 percent rise, data on Wednesday showed.

Read More Australia's economy on fire in first quarter

But instead of rallying, the S&P/ASX 200 ended Thursday down 0.1 percent at 5436.884, essentially flat with early November levels. On Friday, it was 0.3 percent higher in early trade.

"Those (GDP) numbers were good, but the news didn't actually help the share market because a lot of the growth in GDP actually came from exports, mainly resources exports," Oliver said, noting many resource players increased production to compensate for lower commodity prices.

Even the Reserve Bank of Australia (RBA) keeping interest rates at a record low 2.5 percent since August of last year hasn't provided a boost to the market.

Read More Is trouble in store for the Australian economy?

"The low level of rates is reflective of weak growth," Oliver said.

Australia's economy enjoyed 20 years of strong growth thanks to its mining boom, but lost some of its luster recently as the boom showed signs of peaking and growth in China – its largest trading partner - slowed.

In addition, Australia's conservative government delivered the country's harshest budget in 20 years last month; many economists are concerned about the toll it will take on the economy. Business and investor confidence dropped following the budget, while red-hot housing prices eased – a factor that economists worry could dampen consumer spending.

Read More Australia's budget: Harsh or fair?

Goldman Sachs also doesn't expect the market to get much of a boost from low interest rates, even if they are cut further.

"If the RBA delivers the rate cut we forecast for September, we expect the market will take it as more of a bearish signal, emphasizing a weak domestic economy," Goldman said in a note dated Tuesday. "With the response of the economy to the earlier easing having been disappointing, we are concerned that financial conditions are already consistent with subtrend growth just as the sharpest decline in mining investment is likely to be recorded."

The Australian dollar remains stubbornly high despite declines in bulk commodity prices, resulting in tighter macro conditions, it said.

Goldman expects the earnings risks for Australia shares are on the rise and it forecasts only 3 percent earnings per share growth for index shares in fiscal 2015, lower than consensus forecasts.

"Even with the possibility of rate cuts on the horizon, Australia stock valuations are looking stretched and it's time to switch to defensive plays with secure yields," it said.

To be sure, Goldman doesn't expect a sharp drop in the market anytime soon, with the S&P/ASX 200's dividend yield of 4.6 percent, in line with its 20-year average, likely to provide support for the near term.

Read More This could worsen Australia's skilled worker shortage

"Every single ASX sector is trading at a yield premium to 10-year U.S. bonds," it noted. The 10-year U.S. Treasury was trading around 2.58 percent during Asian trade Thursday.

AMP's Oliver also doesn't expect a market selloff in the near term, unless U.S. or global shares weaken significantly.

While global markets have typically taken a seasonal hit this time of year over the past few years, "beyond the seasonal weakness, it's hard to see what could drive the market down" currently, Oliver said.

He also expects shares to recover in the second half of the year, forecasting the S&P/ASX 200 will target 5800 by year-end on expectations China should see improved economic data ahead.

—By CNBC.Com's Leslie Shaffer; Follow her on Twitter @LeslieShaffer1

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