Will the inventory cycle help or hurt in the latter half of 2010?
It’s just one question in a sea of inquiries in the quest to get a handle on how the economy fares in the months and quarters ahead. Arguably it’s one of the more topical issues looming. One view is that the burst of economic activity that gave aid and comfort to last year’s third-quarter GDP (the economy grew by 2.2% in Q3, ending a string of GDP declines) was largely inventory related.
Recall that the financial crisis and Great Recession took a heavy toll on corporate America by early 2009, slashing production activity and leaving warehouses relativley depleted. By the end of last year, a recovery of sorts had set in and one of the catalysts has been the rebuilding of inventories, as suggested by our chart below. Inventory relative to sales fell to a 1.3 ratio by last November, down sharply from about 1.45 early in 2009.
But with the inventory-to-sales ratio back in “normal” territory, the restocking effect is fading. That inspires some to predict that economic growth will turn sluggish in the near future as the benefits of refilling warehouses and the like fades as a stimulus for GDP.
In an essay from last month, PIMCO’s Paul McCulley advised…
It’s true that the fourth-quarter 2009 gross domestic product (GDP) is likely going to be 4%-plus. The inventory cycle is a turbo charger right now. But when we talk about the New Normal growth rate, we’re talking in trends as opposed to single quarters.
The real story here will be told not in the GDP numbers, which are being driven by the inventory cycle, but by real final sales, which will continue to face the headwind of balance sheet deleveraging in the household sector.
One of McCulley’s colleagues at PIMCO—Mohamed El-Erian—tells Bloomberg News: “After an inventory-driven bounce in the GDP growth rate, we are expecting a 2 percent annual pace,” he said. “Also, importantly, it will take years for the U.S. economy to recover to the level of GDP attained before the crisis.”
But not everyone’s so anxious about the inventory effect. Economist Bill Conerly offers a somewhat more upbeat view on the subject, if only marginally so. He still expects a restocking effect that’s a net positive. “The meek economic forecasts may not be anticipating a bounceback in inventories, which make them too pessimistic,” he wrote last week. “However, after four quarters of inventory recovery, the end of re-stocking will push down GDP growth for a quarter, so look for a little bit of roller coaster in your economic data.”
Lest we become too optimistic, Calculated Risk offers a diagnosis to keep us immunized from reading too much into the approaching fourth-quarter GDP report that’s likely to be strong but unsustainable in the near term. The source of this sobering analysis: a fading inventory boost. As Calculated Risk advises, “we are seeing a transitory boost from inventory changes and underlying demand remains weak.”
Nor is this worry limited to the U.S., as a Fistful of Euros explains.
We wrote yesterday that the trend in the labor market will dictate the economic trend in 2010, for good or ill. Perhaps that means inventories will be the second-most critical variable for the economy in the year ahead.