Fisher Investments Editorial Staff
US Economy, Market Cycles

Bare Bottom

By, 09/22/2009

 

Story Highlights:

  • Companies quickly and severely shed inventory at the beginning of and throughout the recession as modern business technologies helped them respond more quickly than ever before.
  • To be sure, aggregate consumption is down, but the vast majority of consumerism continues.
  • At some point, bare-bones inventories need to rise to keep shelves from becoming equally bare and to meet demand.
  • In many areas, inventories continue to fall even as signs indicate economic activity is improving—further evidence companies may soon be forced to ramp up inventory and production quickly and sharply.

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Now that economic Armageddon appears averted and recovery imminent, debate abounds over the pace, shape, timing, strength, etc., etc., of the upturn. But brushing past the purported leading indicators and (always slightly dubious) forecasts, one simple but important economic fact remains: Inventories are near record lows. 

What do low inventory levels mean for economic recovery? That sharp falls in inventory over the course of the recession could consequently lead to sharp rises. We've noted several times in this space that companies quickly and severely reduced inventory at the beginning of and throughout this recession. Modern business technologies helped firms respond quickly to the downturn—hunkering down, cutting headcount, reducing output, getting leaner—likely exacerbating the initial economic slide. Declines in trade and manufacturing inventory levels matched some of the sharpest in history, and capacity utilization is the lowest since 1967. But the upshot is that same technology is capable of just as quick a rebound.

At some point, bare-bones inventories need to rise to keep shelves from becoming equally bare—especially as recession bargains attract consumers and investors. To be sure, overall consumption has fallen, but nowhere near the levels inventories have been reduced to or plants have ratcheted down production. At some point, production will have to come back in line just to satisfy even relatively weaker demand. Simply, weaker consumption does not mean zero spending, and overall US personal consumption is off a mere 1.8% from a year ago.* That's a revealing number—for the most part there is still one heck of a lot of consumerism out there looking for goods and services. In fact, most goods we buy are fairly inelastic. High-profile goods like designer apparel get hit hardest these days, but we tend to keep buying toothpaste and orange juice. 

In many areas, inventories continue to fall even as signs indicate economic activity is improving—further evidence that companies may soon be forced to ramp up inventory and production quickly and sharply. This is true for both manufactured goods and basic materials. For example, steel inventories declined 1% from July to August to the lowest on record. Indeed, steel inventories have fallen continuously since August 2008.* However, auto industry orders for carbon steel are accelerating, while steel shipments have increased each month since bottoming in May. The falling inventory, buttressed against rises in orders and shipments, appear set to drive inventory re-stocking in the near future and a material increase in the capacity utilization rate. And remember, in a global economy, the US competes with myriad other countries for those basic materials and finished goods—emerging markets nations are chugging along at a decent clip these days and demanding more goods every quarter.

As economies recover, the steel example will likely eventually be repeated across industries, if not already. There are, of course, nuances (China may or may not be propping up demand for commodities like iron ore by stockpiling, for instance), but the general message is clear. Though some worry stimulus and easy monetary policy will drive inflation much higher, inflation will remain tame (as has been the case throughout 2009) until increasing business activity and higher capacity utilization drives up wages and prices—a gradual process.

 Thanks to business technologies, many stripped-down companies posted profits tied to productivity gains—even during recession. That is, running leaner. But as economies and demand recover, they'll do well to bolster bare inventories.

 

* Source: Source: Bureau of Economic Analysis; Q2 2009 preliminary GDP values

 

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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