In the second quarter inventory subtracted 1.2% from GDP. It was supposed to add to GDP.
When it didn’t, Bloomberg promptly noted that a rebound in inventory build-up will add to third quarter GDP.
It won’t, because inventory-to-sales numbers remain in the stratosphere. This is something I have commented on for months. Last week, someone else noticed.
As Good As It Gets?
Joseph Calhoun, at Alhambra Investment partners took a look at inventory and other factors and asked is this As Good As It Gets?
The last two years we have seen a pattern of a weak first quarter – for which economists have been searching frantically for an explanation – followed by a second and third quarter rebound. Fourth quarters have tended to the weak side. This cycle was a kind of mini inventory cycle within the larger business cycle. Businesses, told by the Fed and Wall Street economists – possibly redundant – to expect the ever elusive economic acceleration to finally arrive, built inventories in anticipation of what never came. It appears now that US businesses may have finally reached their limit of credulity when it comes to Fed forecasting.
There was no inventory build in the second quarter; indeed inventory subtracted 1.2% from GDP in the quarter. As did almost every other investment category; intellectual property was the lone exception. That isn’t exactly comforting when one considers the nebulous nature of that category. The press almost universally reported the inventory GDP subtraction in positive terms, i.e. inventory contractions are followed by expansions of production to build them again. That is, I believe, the triumph of robotic article generation, algorithms copying what has been said in past articles, ignoring the context. It is often true that inventory contractions are followed by increases in production – but not when inventory/sales ratios remain elevated even after a contraction. And slowing of inventory accumulation has not yet reduced those ratios to levels associated with recovery and certainly not enough to warrant an increase in production.
And while everyone concentrated on the inventory numbers, the more important investment categories were mostly ignored. Gross private domestic investment contracted 9.7% from the first quarter which wasn’t exactly gangbusters either. Year over year GPDI is now down 2.5% a number not seen outside recession since the second quarter of 1967. In other words, it’s pretty darn rare. Even residential investment was down in the quarter – by a not insignificant 6.1%. Maybe last week’s new home sales report was good news – up 25% year over year – but starts and permits are down year over year and Case Shiller says prices have stopped rising. Last week’s durable goods report certainly didn’t offer any rays of sunshine for the goods side of the economy; that report was bad from top to bottom, overall down 6.4% year over year.
The US economy is not in recession – yet – but it is surely slouching slowly in that direction. The drop in investment is very concerning since it is investment that leads; consumption is a consequence of growth not a driver of it. From 2012 to 2015 the economy grew at a 2.2% pace. With this quarterly release and downward revisions to Q4 2015 and Q1 2016, we now have 3 consecutive quarters of 1% growth. And I don’t expect it to get better in the third quarter either. We have an election in November and with none of the above winning in a landslide right now I would not expect a surge in corporate investment. I have never bought into the secular stagnation theory but for now, this may be as good as it gets.
Inventory-to-Sales
Unless sales pick up, and perhaps even if sales pick up, there will be no inventory build.
On July 12, I noted Inventory-to-Sales Ratios Extremely Elevated. Here are some charts.
Overall Inventory-to-Sales Ratio
Motor Vehicles Inventory-to-Sales Ratio
Durable Goods Inventory-to-Sales Ratio
Apparel Inventory-to-Sales Ratio
What’s Behind the Inventory Crisis of 2016?
Kiss the idea goodbye that inventories need to be replenished. But why are they so high in the first place?
Please consider What’s Behind the Inventory Crisis of 2016?
The last time the inventory-to-sales ratio was this high was 2009, when we were in the throes of the Great Recession – people lost jobs, businesses closed, nobody was spending, nobody was growing.
What does it mean that inventory levels are this high in 2016? Are consumers not spending? Are we headed for another recession? Or are other forces at work?
One major culprit is the way consumers shop. Their expectations have changed. This is the age of Amazon Prime, Instacart, Uber and Lyft. Free shipping. In-store pick-up. 1-hour delivery. Easy exchanges and returns. Above all – convenience. If it isn’t convenient for a customer to buy something they want, they won’t buy it – or they’ll buy it somewhere else. Fulfillment has usurped the throne of customer satisfaction.
One common tactic has been to keep buffer inventory on hand. Out-of-stock inventory kills customer loyalty. Not being able to fulfill quickly kills customer loyalty. But having lots of inventory doesn’t equate to efficient fulfillment.
The Business Model
J.C.Penney recently announced its plan to test out a new business model with its supplier, Ashley Furniture. J.C.Penney won’t carry any Ashley Furniture inventory in stores or in its distribution centers. Instead, it’ll just hold floor samples and when customers choose to purchase an item, it will ship direct to consumer from Ashley Furniture. If successful, J.C.Penney hopes to extend this showroom strategy to other departments like appliances.
Execution
Wal-Mart Stores, Inc. recently announced that it is employing drones to manage its inventory. The drones would move through a distribution center, capture images, and flag misplaced items. The process would allow Wal-Mart to check inventory in a day, instead of in a month when it’s done manually. For Wal-Mart, using technology to enhance visibility is a big part of getting a handle on inventory.
Inventory Management by Drones
It’s unrealistic to blame the entire inventory buildup on Amazon and online shopping. We also have a saturation of stores, all duplicating inventory.
Drones can help manage inventory and so can a change in the business model such as J.C. Penny hopes to do with furniture. Both point to a drawdown in inventory, not an inventory revamping as has been widely touted in mainstream media.
If consumer spending falters, the inventory-to-sales ratio will stay elevated on top of it all.
Third quarter GDP is likely to be another disappointment.
Mike “Mish” Shedlock
The inventory to sales ratio can fall quickly when companies start to close and have to liquidate.
Only if the liquidation buyers aren’t former competitors who think they are getting a “deal”.
Is it possible for two stores to be counting the same stuff as their own inventory?
Not Likely – And it would be fraudulent
Coupled with a drop in imports and domestic freight, HOW can we have “increased retail sales” which are propping up the phony GDP numbers? Once again, a Democratic administration NEVER has a recession. And meanwhile, ALL the underlying numbers clearly show we are in one!
Like
Maybe the problem is people have less money to spend because housing, health care, and education costs keep going up much more than their paychecks.
Nail meet hammer
I’d like to see how that drone picks up the box.
Does anybody remember the rise of Japan and JIT in the 70s when high interest rates supposedly made inventory too expensive to hold.?
What is the logic now.?
JC Penny’s business model sounds like it was developed by a SJW. How long before Ashley opens a staffless outlet to showroom their own wares and keep the markup.? Assuming they are not run by SJWs.
“The last two years we have seen a pattern of a weak first quarter – for which economists have been searching frantically for an explanation…”
People are having to cut spending first quarter, due to Christmas season spending and Obamacare premium increases?
One reason was accelerated depreciation for business. I think in 2015 Congress finally made it permanent. For a few years it was due to expire at year’s end. Business pulled forward next year’s capital expenditure into Q4. But expiration would only be short lived. At some point during the year Congress invariably voted to extend … for 1 more year. Wash rinse repeat.
http://www.section179.org/section_179_deduction.html
Velocity of Money
“It won’t, because inventory-to-sales numbers remain in the stratosphere.”
Yes. A good old fashion inventory correction led recession on tap.
And not a damn thing the Federal Reserve can do about it … and anyone preaching “no recession” as long as FR keeps monetary policy on full throttle is utterly CLUELESS. At best, monetary policy extended the expansion phase a bit.
An inventory anecdote.
I own a small business. 0ne of my vendors is a Warren Buffet owned company. A few weeks ago the rep sent out an email to select customers on an inventory BLOWOUT of discontinued and/or closeouts (perfectly good products, though). Customers had 48 hours to place order on products that ranged in price from 2 cents to 10 cents on the dollar. My business placed the largest order ever by volume (not total $). Talked to the vendor rep after placing order and said warehouses were stuffed and they offered this promotion to clear space … and what not sold was DESTROYED.
Needless to say our orders (at standard pricing) with them will be lower for the foreseeable future as we work off the added inventory.
But go ahead Buffet … keep telling the public everything fine and vote HRC.
To add to your point, the Fed has been pushing demand forward for so long now that it has now pushed supply forward. Central banks have pushed forward all the demand they possibly can and now comes the inevitable readjustment of forecasts by suppliers.
Seems like utilized capacity will be falling, and we know that is happening in China right now.
“Central banks have pushed forward all the demand they possibly can”
Well, not ALL the demand, for sure. Shopping coupons with pictures of helicopters are still not even printed, let alone distributed and used. So there’s still some wiggle room.
Judging by how heavy this country has gotten it looks like it pushed food demand forward as well 😛
Businesses will destroy inventory and write off the loss under non GAAP. Then beat earnings.
Drones are tech advance but WMT employees are so dumb the tech advance is negated.
3Q will be worse.
When I read the headline to this blog and saw: “Can drones cure the inventory crisis?” I thought Mish was referring to the vernacular associated w/ the males species that participates in a great deal of fertilization but little work, which struck me as an oxymoron. We do have an abundant supply of “drones” in society, especially in the highest ranks of government who form economic policy and impact “inventory”.
The use of mechanical drones may well improve efficiency and enhance the bottom line at many business. But I’m afraid it will produce more human drones. So it’s a tradeoff, as most things are in life.
“Wal-Mart Stores, Inc. recently announced that it is employing drones to manage its inventory. The drones would move through a distribution center, capture images, and flag misplaced items. The process would allow Wal-Mart to check inventory in a day, instead of in a month when it’s done manually. For Wal-Mart, using technology to enhance visibility is a big part of getting a handle on inventory.”
Sure, that’ll do it (/sarc).
I had a conversation with the manager of the Super Walmart in the wealthy part of this city while in the store. I mentioned that some time before I’d researched the best Blue-ray player to buy and saw that it was offered in Walmart stores. The store’s inventory said they had six on hand… they had ONE.
I asked how that was possible with computer-tracked inventories where each one sold should be automatically removed from the on-hand stock at, from what I was previously told during my Blu-ray purchase, the end of each day. She said that so many things simply walked out the door. Since these items are security tagged, I asked how that is possible. She claimed it was the warehouse employees. I found that equally hard to believe. I don’t know if she knew what she was talking about or just making excuses for a REALLY buggy inventory tracking system.
They will cook thw numbers for the election. The people inside will do anything to install their drone Hillary in office.
The mainstream media act as cheerleaders for Hillary. She can do not wrong. If Trump farts in b-flat instead of c-sharp – they swarm on him like Piranha.
The BIG MONEY looks at Trump like Dracula. He threatens the “Pay for Play” system. All the BIG MONEY GOP’ers like the Koch Bros. are in Hillary’s corner. Go figure.
This Country is as good as done, Greg. Today it’s for sale to the highest bidder. It’s over.
I just thank God I’m as old as I am.
No Old Timer, the Koch Bros are not that stupid:
http://www.snopes.com/koch-brothers-officially-endorse-hillary-clinton/
Beware internet rumors and misleading articles in Newsweek and Time.
Besides, one Koch is holding a fundraiser for The Donald:
http://fortune.com/2016/08/04/donald-trump-william-koch/
No Old Timer, the Koch Bros are not that stupid:
http://www.snopes.com/koch-brothers-officially-endorse-hillary-clinton/
Don’t believe everything you read on the internet, and Newsweek and Time.
Also, one Koch Bro is holding a fundraiser for The Donald:
http://fortune.com/2016/08/04/donald-trump-william-koch/
FRAUD as a Business Model has been very successful for large corporations and individuals who can make very large donations to politicians.
When the plea deal represents a small cost compared to the reward, it becomes just a cost of doing business in this successful Business Model.
Hi Mish,
Can the apparel to inventory ratio be explained by the fact that the Millenials value experience over materialism and don’t buy as many clothes as their parents? The trend has only been up since 2010. May be the trend can be explained by Baby Boomers (the customers) retiring/losing jobs or simply dropping off.
Regards
Guido
Inventories will continue to build. Slick marketing and advertising won’t make a big difference. When consumers are tapped out and/or have no job, their buying habits are changed for them. This can only accelerate.