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Inventories Send Troubling Signal on US Economic Growth

Posted by Joseph Trevisani on Mar 9, 2016 3:08:26 PM

Inventory production is good for the economy now, but unless it is matched by sales, it is bad for the economy later.

That is the current predicament of U.S. firms. Companies boosted production in January, inventories rose 0.3 percent in anticipation of stronger sales. Economists had forecast a 0.2 percent inventory reduction.

But sales have not improved.  In January wholesale trade sales fell 1.3 percent, far more than the 0.3 percent predicted decline.

What is worse, sales in December were revised down to -0.6 percent from -0.3 percent and inventories were revised higher to flat from -0.1 percent.  Firms sold less and amassed more in December and January that they had expected.

Wholesale sales have fallen for four straight months and for eight of the last 12.  Inventories, however, rose in January, were flat in December and declined in only three of the last 12 months.

The ratio of inventories to sales climbed to 1.35 in January, the highest it has been since April 2009. It was 1.33 in December. This ratio has been rising, with pauses, since it briefly dropped to 1.29 last April and it  has been higher every month since October.  

Falling sales and rising production mean two things, neither good for business nor the economy.  

First, unless inventory begins to move out of warehouses into the retail selling chain, manufactures will soon begin to see lower orders as wholesalers stop booking new goods until the old ones are sold.

Fewer orders to factories means that the contribution to gross national product (GDP) from production in February and March and perhaps into the second quarter will be lower as the backlog of goods is cleared.  

Factory orders were 1.6 percent higher in January partially reflecting this gain in inventories, though they were lower than the 2.1 percent forecast. Factory orders fell 2.9 percent in December when inventories were flat.  Orders for February will not be issued by the Census Bureau until April 4th. 

Second, inventory is often a wasting asset. It costs a firm money to store goods and the longer they wait for sales the lower their value. Business profits will take a hit as income from sales diminish when firms are forced to cut prices to move inventory.

Lower selling prices will also put downward pressure on the overall price level, inhibiting the Fed’s search for 2 percent in the core personal expenditure price index. It was 1.7 percent in February. 

The historical position of the inventory to sales ratio also indicates problems ahead for the U.S. economy.  

In the 24 years of this series, the ratio has been this high or higher for only four months, from December 2008 to March 2009 at the height of the financial crisis and recession.  

It has been to 1.33 or above for more than one month only three times since the data began in January 1992.  In two of those instances a recession followed.  

The exception is the end of 1998 when the ratio was at 1.33 and more for seven months from August through February 1999. The economy averaged 6.0 percent annualized growth in the second half of 1998 and the inventory build probably stemmed from overproduction rather than slowing sales.  

In April 2001 the advent of 1.33 in the inventory to sales ratio came two months after the recession began, according to the National Bureau of Economic Research calculation.  In 2008 the sudden jump to 1.35 in November from 1.24 in October, came almost a year after the recession had started in November 2007. 

A U.S. recession in the next several quarters is not a likely denoument, despite the signal from the inventory to sales ratio. Not while the much larger service sector seems to be holding its own and jobs are wages are still rising.  

However, unless sales pick up, a further decline in manufacturing is a very possible outcome.  


Joseph Trevisani

Chief Market Strategist

WorldWideMarkets Online Trading

Charts: Bloomberg





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