It is not possible to predict future events in stock markets or economies, but it is important to consider credible "what if" scenarios and how they might impact your portfolio's returns. These "what if" scenarios can often stem from a current issue like the recent commodities price collapse.
Over the past 12 months the price of iron ore and oil has collapsed around 50%, whilst coal prices have been in slow decline for years. Iron ore and coal are Australia's largest exports and LNG is rapidly gaining importance as our mega-projects in Queensland and WA come online. The collapse in prices is threatening the survival of many projects and operations Australia wide.
It is no wonder that all companies in these sectors are slashing operational and exploration expenditures, including jobs, in an effort to stay afloat. For many, this won't be enough. Atlas Iron Limited (ASX: AGO) recently announced it was suspending most of its operations due to low iron ore prices. It is likely more will follow.
I would recommend investors avoid the resources and associated services sector. The majority of these companies, including BHP Billiton Limited (ASX: BHP) and Rio Tinto Limited (ASX: RIO), are trading near multi-year lows and it may be tempting for investors to pick up a bargain. With the outlook for commodity prices uncertain, the best way to protect your portfolio is to avoid these sectors in the current climate.
"What if" – unemployment increases in Australia.
Although the unemployment rate unexpectedly dropped in April to 6.1%, many pundits are expecting unemployment to increase in the near future. Steve Miller, investment strategist at Blackrock, expects unemployment to reach 7% by the end of the year, according to a recent article in The Sydney Morning Herald. Rising unemployment in the resources operations, construction and services industry will be a likely contributor to overall unemployment which could put strain on the Australian housing market.
"What if" – A substantial collapse occurs in Australian property prices.
If unemployment continues to rise it could trigger a protracted downturn in Australian property prices, as discussed recently by Bruce Jackson and Joe Magyer.
One of the first sectors to be sold off will be our big banks, including Commonwealth Bank of Australia (ASX: CBA) and National Australia Bank Ltd. (ASX: NAB). The big banks are sitting at lofty valuation levels, which depend highly on a strong national housing market.
Investors starting positions in the big banks today will find it difficult to achieve market-beating returns in the future and also face the risk of substantial losses should the Australian housing market falter.
What should you invest in?
To help protect your portfolio during an Australian economic downturn investors should look toward stocks with defensive qualities including healthcare and consumer staples. They should also look at companies generating a majority of earnings offshore.
There is growing global demand for biopharmaceutical giant CSL Limited's (ASX: CSL) products and around 90% of total revenue is from outside Australia, making it worthy of consideration for your portfolio.
The consumer staples sold at Woolworths Limited (ASX: WOW) will continue to be required by Australians in all economic conditions making it an ideal defensive stock. Shares are currently trading near their lowest price in two years at $28.50 and would make a great addition to your portfolio.
It is not just commodity prices and the housing industry that can see prices collapse, the stock market is also highly vunerable. As the ASX flirts with 6,000, some experts are predicting a market crash…
