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Good times expected to roll on for Australia stocks

Australia equities are a resilient lot, shrugging off a slew of economic headwinds this year to trade at nearly six-year highs. And analysts say the good times are expected to roll on.

The country's benchmark S&P/ASX 200 has clocked steady gains of almost 4 percent so far this year to trade near the 5,543 level on Monday, despite a slowdown in top trading partner China, subdued consumer confidence and a persistently strong Australian dollar. Last Friday, the index touched a six-year peak of 5,561.

"My central outlook is that the market will move gradually higher in line with moderate earnings growth over the next few months. It's a period of gently upward sloping drift," said Ric Spooner, chief market analyst at CMC, who sees the index climbing to 5,700 by year-end, or 3 percent higher than current levels.

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John W Banagan | Stone| Getty Images

In addition to moderate earnings growth, the market will be buoyed by the improving global macro picture as the recovery in the U.S. picks up steam and as signs of stabilization emerge in China, Spooner said.

China reported 7.5 percent annual gross domestic product growth in the June quarter as Beijing's stimulus began to filter through world's second largest economy, up from 7.4 percent in the previous three months, but still a far cry from double-digit growth rates seen just a few years ago.

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Evan Lucas, a strategist at IG, agrees the current trend is still to the upside as Australia's high quality dividend stocks remain in favor.

"The market is currently testing a strong resistance level of 5,540. If it holds above this level, it would be a positive signal," Lucas noted.

The Australian market's gains this year have been led by blue-chip dividend stocks including telecommunications giant Telstra and the big four banks -Commonwealth Bank of Australia, Westpac, ANZ and National Australia Bank - which make up around 23 percent of the index's market capitalization, according to IG.

Geopolitical uncertainty has seen investors jump back into the banks, which are regarded as safe and offer attractive dividend yields of between 4.7-5.8 percent.

In the recent weeks, a recovery in mining stocks has helped sustain gains in the market. Shares of Rio Tinto and BHP Billiton have risen 6 and 9 percent, respectively, over the past month, helped by better-than-expected China economic data.

"If we get better-than-expected earnings for Australian corporates, the index could hit 5,600 in the next three months," Lucas added. The Australian reporting season kicks off in August.

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Addressing concerns over Australia's macroeconomic outlook, Lucas says while recent economic data such as the June employment report may appear bleak, there is there a silver lining.

"In June, the unemployment rate went up, but participation also went up - which is a sign that people are coming back to the job market," he said.

Australia's unemployment rate rose to a higher-than-expected 6 percent in June from 5.9 percent in May. At the same time, the workforce participation rate, or the proportion of working-age people at work or actively seeking work, rose to 64.7 percent in June from 64.6 percent in the previous month.

Lucas, however notes that there are a couple of wildcards for the market including how investors will react when clarity emerges over a timeline for a rate hike by the Federal Reserve and whether the Reserve Bank of Australia (RBA) will cut interest rates.

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"There's a suggestion that the RBA is turning dovish again and if we did see a rate cut - I find it unlikely at this point - it makes the case for the yield trade even stronger, which would be supportive for the market," he said.

In the minutes of its July board meeting, the RBA indicated that it would leave interest rates unchanged for some time despite concerns about non-mining growth and the high Australian dollar, saying there was enough monetary stimulus in place to support economic activity.