Australia's growth rate is slowing.
Indeed, it appears China's unprecedented economic engine will shift gears from being one led by infrastructure growth, to consumption. For Australia, this means a slowing of the mining sector and, in turn, the broader economy. At least for a little while.
Rich in iron ore, gold, coal and other raw materials, mining is what Australia is known for. In fact, metal ores and minerals, gold, and coal generated 48% of export revenue in November 2015, according to the Australian Bureau of Statistics, down 200% basis points (2%) from September.
In the years leading up to January 2014, the Australian economy was riding high on commodities. Export levels were surging, and we were receiving good prices for our products, thanks to buoyant commodity markets and a resilient Australian dollar.
Tough times ahead?
Unfortunately, the winding down of mining operations can wreak havoc on economies – locally and nationally. The effects of boom and bust mining cycles are evidenced by the countless artefacts left behind by past generations. Rusted mining machinery and hazardous pits and shafts adorn rural communities around the world.
For Australia, it may be no different.
China's seemingly insatiable appetite for our materials bought millions upon millions of tonnes of new supply into global markets. Now, yesterday's added supply is coupling with a transitioning Chinese economy, one which won't demand nearly as much steel, concrete, coal and copper.
Sure, there'll be significant demand from China's huge manufacturing sector. However, it was just a matter of time before the development of ghost cities, enormous bridges, and freeways to nowhere, came to an end.
It's economics 101. When investing in the resources sector, investors need to remember that commodities markets – like those for iron ore, coal, wheat, etc., – are price taking. That means, if you and I both produced 1kg of coal, a customer would choose the producer with the lowest price because the two pieces of coal are no different.
At a macroeconomic level, it's no different. While iron ore prices may have remained high, when demand for raw materials (mostly from China) exceeded supply, it was only a matter of time before existing mines were expanded and new mines came online, bringing supply and demand (and prices!) back to their equilibrium.
Is a recession coming for Australia?
For the most part, China saw Australia through the global financial crisis (2008/2009) relatively unscathed. However, while we are now producing more raw materials than ever before, the prices we are receiving for our products are far less (see the chart above). That'll put pressure on the non-mining parts of our economy to pick up the slack and keep us on a trajectory towards growth.
A recession is defined as two consecutive quarters of negative growth (yes, I know there's no such thing as 'negative' growth).
Unfortunately, I have no idea whether we'll encounter a recession this year, next year or this decade. But one thing I do know is: it's only a matter of time. Australia is currently experiencing the second-longest streak of non-stop economic growth of any nation.
Recession proof your portfolio
While a share market crash isn't always a feature of a recession, they can occur at any time. Fortunately, as I explained to some friends recently, falling into a recession won't be the end of the world. Sure, if you're nearing retirement (e.g. in the next five or so years) and have a majority of your money tied up in shares and investment property — a recession will be bad news. Moreover, if you're using a lot of debt, have more credit cards than you can count and are living pay check to pay check, you may want to speak to a trusted and licensed financial advisor. The share market is no place for cash that may be needed in the next three to five years.
If you don't need to access your money in the next five years, have a diversified portfolio, a stable job and, say, at least, six months' worth of living expenses put aside in a high-interest savings account, a recession may actually bring more investment opportunities than would otherwise be the case.
And if you're investing for yourself or your family, it's also important you have diversification. Indeed, you should have exposure to different asset classes (shares, fixed income, property, cash, etc.) and across geographies (e.g. Australian, US and European shares). Australia's share market is less than 3% of all share markets around the world.
So while Telstra Corporation Ltd (ASX: TLS) and Wesfarmers Ltd (ASX: WES) – the owner of Coles, Bunnings, Kmart and more — will help you survive a China-led Australian recession, shares on American or European exchanges may not even notice the downturn in Australia.
Foolish takeaway
The Australian economy and share market could grind to a halt at any time. However, as I said on Channel 10's The Project last week, our economy is resilient and our share market has provided exceptional returns over the ultra-long term (it's been the best performing share market since January 1900). Therefore, provided you're not investing for short-term gains (you're inevitably going to be disappointed if you are), share markets are still a great way to invest your money in 2016, in my opinion.
For anyone looking to start out in investing this year, against a backdrop of a potentially slowing economy, I recommended owning some Exchange Traded Funds (ETFs). The iShares Global Consumer Staples ETF (ASX: IXI) and iShares S&P 500 ETF (ASX: IVV) may be good places to start. Throw in Wesfarmers, Telstra, ResMed Inc. (CHESS) (ASX: RMD) and Cochlear Ltd (ASX: COH), and you're on your way to building a rock-solid long-term share portfolio.
