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.