ASX: Iron ore plunges

Iron ore spot prices plunged from $120 to $106.50/tonne in two days. Penetration of the rising trendline is highly likely and would warn of a strong correction. A spike up is often followed by a spike down.

Iron Ore

The ASX 200 retreated from its 2007 high at 6830. Penetration of the rising trendline is now likely and would warn of a correction. The first line of support is 6350, with stronger support at 6000.

ASX 200

We have increased the level of cash in our Australian Growth portfolio.

Iron ore tailwinds lift the ASX

Further increases in iron ore prices are predicted. Enrico de la Cruz at Mining.com reports:

Singapore-based steel and iron ore data analytics firm Tivlon Technologies is keeping its price forecast of $150 a tonne by October.

“We expect the launch of infrastructure projects in China to peak in the third quarter and further uplift demand for steel,” it said in a note.

Narrow consolidation is a bullish sign, suggesting another advance.

Iron Ore

The Materials index continues its up-trend. A Trend Index above zero would signal increased buying pressure.

ASX 200 Materials

Financials continue to test resistance at 6450 but face headwinds from the housing market and construction.

ASX 200 Financials

The ASX 200 is testing its 2007 high at 6800. A rising Trend index indicates buying pressure. Penetration of the rising trendline on the index chart is unlikely but would warn of a correction.

ASX 200

We maintain a high level of cash in our Australian Growth portfolio because of expected headwinds from housing and construction.

ASX 200: Iron ore tailwinds continue

The ASX continues to enjoy a massive tailwind, with iron ore spot prices holding above $120/tonne. Prices are expected to moderate, with Brazilian exports recovering. Clyde Russell at Mining.com comments:

“Even if Brazil’s exports do remain slightly below normal, it may be the case that the iron ore forward curve is currently too optimistic. The Singapore Exchange front-month contract closed at $121.24 a tonne on Wednesday, while the six-month contract was at $100.52 and the 12-month at $89.52. This shows traders do expect prices to moderate…”

Iron Ore

The Materials index continues to climb, with rising troughs on the Trend Index signaling buying pressure.

ASX 200 Materials

REITs continue their strong up-trend, in expectation of lower interest rates. The equity (dividend) yield on VAP/ASX 300 REITs has fallen to 4.3%.

ASX 200 REITs

Financials are testing resistance at 6450 but face headwinds from declining house prices and construction work.

ASX 200 Financials

The ASX 200 is headed for a test of its 2007 high at 6830, with a rising Trend index indicating buying pressure. Penetration of the rising trendline on the index chart is not likely but would warn of a correction to test support at 6000.

ASX 200

We continue to maintain a high level of cash in our Australian Growth portfolio.

ASX tailwinds v. headwinds

The ASX continues to enjoy a massive external tailwind, with iron ore spot prices holding at $120/tonne.

Iron Ore

Headwinds stem mainly from domestic sources. Low employment and disposable income growth have slowed consumption, especially of durables such as housing and motor vehicles. Construction work done in the private engineering sector (mainly mining and energy related) continues to decline after a dramatic fall in 2013-2015. Public sector spending is also tailing off as the NBN roll-out winds down.

Australia: Construction Work Done

Private sector building still shows some resilience but is expected to fall as approvals for new residential construction decline (source: ABS).

Australia: Building Approvals

My concern is that the headwinds will outlast the tailwind, in which case all three construction sectors could fall to 2006 levels.

The ASX 200 continues to advance, headed for a test of its 2007 high at 6830. A declining Trend index would warn of rising selling pressure, while penetration of the rising trendline on the index chart would signal a correction to test support at 6000.

ASX 200

We continue to maintain a high level of cash in our Australian Growth portfolio.

ASX: Iron ore at $120

The ASX is still enjoying a massive tailwind from iron ore prices, with  spot prices close to $120/tonne.

Iron Ore

My concern is how long this tailwind will last. But the ASX 200 advances unperturbed, heading for a test of its 2007 high at 6830. Penetration of the rising trendline is unlikely but would warn of a correction to test support at 6000.

ASX 200

I continue to maintain a high level of cash in my Australian Growth portfolio because of long-term headwinds.

ASX 200 plain sailing at present

Iron ore tailwinds show no signs of abating, with spot prices close to $110/tonne.

Iron Ore

It’s all plain sailing, with the ASX 200 advancing towards its 2007 high at 6830. Penetration of the rising trendline is unlikely but would warn of a correction to test support at 6000.

ASX 200

I continue to maintain a high level of cash in my Australian Growth portfolio because of long-term headwinds.

Australia needs to break the downward spiral

Ross Gittins, Economics Editor at The Sydney Morning Herald, sums up Australia’s predicament:

“The problem is, the economy seems to be running out of puff because it’s caught in a vicious circle: private consumption and business investment can’t grow strongly because there’s no growth in real wages, but real wages will stay weak until stronger growth in consumption and investment gets them moving.

Policy has to break this cycle. But, as [RBA governor] Lowe now warns in every speech he gives, monetary policy (lower interest rates) isn’t still powerful enough to break it unaided. Rates are too close to zero, households are too heavily indebted, and it’s already clear that the cost of borrowing can’t be the reason business investment is a lot weaker than it should be.

That leaves the budget as the only other instrument available. The first stage of the tax cuts will help, but won’t be nearly enough…..”

Cutting already-low interest rates is unlikely to cure faltering consumption and business investment. Low wage growth and a deteriorating jobs market are root causes of the downward spiral and not much will change until these are addressed.

Low unemployment is misleading. Underemployment is growing. Trained barristers working as baristas may be an urban legend but there is an element of truth. The chart below shows underemployment in Australia as a percentage of total employment.

Australia: Underemployment % of Total Employment

How to halt the spiral

Tax cuts are an expensive sugar hit. The benefit does not last and may be frittered away in paying down personal debt or purchasing imported items like flat-screen TVs and smart phones. Tax cuts are also expensive because government is left with debt on its balance sheet and no assets to show for it.

Infrastructure spending can also be wasteful — like school halls and bridges to nowhere — but if chosen wisely can create productive assets that boost employment and build a healthy portfolio of income-producing assets to offset the debt incurred.

The RBA has already done as much as it can — and more than it should. Further rate cuts, or God forbid, quantitative easing, are not going to get us out of the present hole. What they will do is further distort price signals, leading to even greater malinvestment and damage to the long-term economy.

What the country needs is a long-term infrastructure plan with bipartisan support. Infrastructure should be a national priority. There is too much at stake for leadership to take a short-term focus, with an eye on the next election, rather than consensus-building around a long-term strategy with buy-in from both sides of the house.

ASX 200: Don’t ignore the headwinds

The ASX 200 is advancing to test its all-time (2007) high at 6830, having respected its new support level at 6350.

ASX 200

Shane Oliver, AMP economist, argues that an Australian recession is unlikely as the economy has tailwinds as well as headwinds:

  • mining exports have surged on the back of strong iron ore prices, narrowing the current account deficit;
  • a falling Aussie Dollar will act as a shock absorber to stabilize the economy;
  • the Australian government has strong capacity to stimulate the economy, through tax cuts and infrastructure spending;
  • house prices may be falling but there is no panic selling; and
  • the RBA has further capacity to cut rates if necessary.

The tailwinds can be summed up in two words: iron ore. Without high ore prices, our current account deficit and fiscal deficit would be much larger, limiting the ability of government to stimulate the economy.

Australian headwinds, on the other hand, can be summed up by one words: jobs. High ore prices do not create many jobs.

Job growth is falling and unemployment is expected to rise.

Low jobs growth is eroding consumer confidence, flagged by falling spending on durables such as motor vehicles.

ASX 300 Autos & Components

And housing.

House Prices

The critical question is: will the iron ore tailwind last long enough to save the Australian economy from recession?

High iron ore prices are unlikely to last long. From Reuters on Thursday:

Mining giant Rio Tinto on Thursday lowered its guidance on volumes of iron ore it expects to ship from the key Pilbara producing region in Australia for the third time since April, citing operational problems.

The guidance cut came just hours after Brazilian miner Vale, the world’s No. 1 iron ore producer, said late on Wednesday that it will fully resume Brucutu operations within 72 hours, after a favourable ruling from an appeals court…..Brucutu, which has been operating at only a third of its capacity, was shuttered in February as Vale’s mine operations came under close scrutiny after a tailings dam collapsed in Brazilian town of Brumadinho, killing more than 240 people…..The full operation of Brucutu “should help alleviate concerns about tightness in the market,” said ANZ Research analysts in a note. “However, issues at Rio Tinto’s operations suggest the market still has some challenges ahead.”

Rio Tinto said it now expects shipments from Pilbara at between 320 million tonnes and 330 million tonnes, mostly lower-grade and lower-margin product. Its previous target was between 333 million tonnes and 343 million tonnes.

Vale at the same time reaffirmed its 2019 iron ore and pellets sales guidance of 307 million to 332 million tonnes, saying sales should be around the midpoint of that range, instead of the low end of the range as previously expected.

Chinese steel production is strong.

China Output

Housing construction is rising.

China Housing

But rising housing inventories warn that construction is running ahead of demand, which is likely to exert downward pressure on prices.

While Chinese automobile production is faltering. From WSJ:

Auto sales in China declined for an 11th straight month in May, with the slump in demand showing no sign of easing and the country’s automotive industry bracing for losses tied to new emissions standards.

Sales for the latest month fell 16% from a year earlier, to 1.91 million vehicles….

I am not sure how long the iron ore shortfall will last but I wouldn’t bet on high prices by the end of the year. Nor would I bet on the G20 meeting between Donald Trump and Xi Jinping resolving US-China trade differences.

That leaves uncertain tailwinds and far more certain headwinds.

A good time to be cautious

Markets are buoyant with the S&P 500 headed for another test of its all-time high at 2950. Bearish divergence on Twiggs Money Flow warns of secondary selling pressure but the overall technical outlook looks promising.

S&P 500

So why should it not be a good time to invest in stocks?

First, the yield curve warns of a recession in the next 6 to 18 months. The 10-year Treasury yield is below the yield on 3-month T-bills, indicating a negative yield curve. This is our most reliable recession signal, with 100% accuracy since the early 1960s.

Yield Differential

Annual jobs growth has declined since January. Further declines in the next few months would further strengthen the recession warning.

Annual Growth in Total Payrolls

Small cap stocks in the Russell 2000 lag well behind the S&P 500, indicating that investors are de-risking.

Russell 2000 ETF

Cyclical sectors like Automobiles & Components also offer an early warning, anticipating slower consumer spending on durables such as housing, clothing and automobiles.

S&P 500 Automobiles & Parts

Lastly, the historic Price-Earnings ratio is above 20 (PE and PEmax are equal at present), indicating stocks are over-priced.

S&P 500 historic PE ratio based on highest prior earnings

It’s a good time to be cautious.

ASX 200: Materials rocket but Financials fade

Last week I wrote that I had zero confidence in the ASX 200 breakout but you can’t argue with the tape. The ASX 200 retracement respected its new support level at 6350 and commenced a fresh advance. Money Flow completed a trough high above zero, signaling strong buying pressure.

ASX 200

Iron ore is a big contributor, rocketing to $106/tonne.

Iron Ore

Materials followed suit, breaking resistance at 13,500 suggesting a fresh advance.

ASX 200 Materials

The housing rally in response to the recent RBA rate cut has fizzled out, with CoreLogic reporting lower auction clearance rates last weekend:

The combined capital city final auction clearance rate came in at 48.3 per cent last week, which was lower than the 58 per cent the previous week. The lower clearance rate was across a lower volume of auctions over what was the Queen’s birthday long weekend, which saw 805 homes taken to auction, down on the 1,661 auctions the prior week.

The Financials advance has also lost impetus, with lower peaks on the Money Flow Index warning of increased selling pressure. Reversal below 6000 would warn of another correction.

ASX 200 Financials

The market is discounting the potential impact of a US-China trade war on Australia, relying on a large Chinese injection of fiscal stimulus to steady the ship. They may be right but Chinese officials have been talking this down for the past few months.

We hold 46% of our Australian Growth portfolio in cash and fixed income securities because of high uncertainty from (1) the US-China trade war; and (2) declining house prices and their potential impact on under-capitalised banks — leveraged at nearly 20 times common equity (CET1).