Cycling Backward?

by: Alhambra Investment Partners

By Jeffrey P. Snider

Wholesale sales and inventories are still relatively better in June than earlier in the year, though the level of inventory looks nothing like what is being counted for GDP. Overall, the pace of sales continues to be relatively stuck in a low-growth track that shows little signs of being elevated.

For an economy being determined marginally by inventory, supply chain levels here are still quite high. The accumulation at the wholesale level can at least be explained, somewhat, by the actions of retailers. The question now is why retailers are continuing to stockpile inventory at these relatively lower sales levels.

Again, nothing here conforms to the revised picture provided by the latest GDP estimates, rather the prior GDP inventory figures were far more consistent with inventory action shown above (or until it too gets majorly altered by "updated" regressions). Whatever the ultimate relation between these series, it remains inconsistent as to why inventory at the retail level has been growing so steadily. One factor is undoubtedly automobiles, and that sector has been the only place where growth has been steady.

You would think, however, that last year's experience should have been at least a warning about the downside of following permanent sunshine of that type. That is particularly true as sales have clearly slowed from their earlier pace.

In the context of recent historical cycles, the initial phase of the "recovery" period was far more rapid than either of the two previous breakouts. That was certainly an element of symmetry as the contraction phase beginning in June 2008 (wholesale sales and inventories were still growing throughout the first half of the Great Recession) was an order of magnitude worse than either of the prior two recessions.

However, somewhere toward the middle of 2011 the growth paradigm switched. Growth in the current cycle is now underwhelming by a significant degree in comparison when symmetry dictates further and further outperformance.

It was also right around that time that inventory-to-sales ratios began their precipitous rise and the economy as a whole became almost fully captured by inventory mini-cycles. Again, however, there is no ready explanation as to why inventory has not followed more closely with sales, especially on the retail side. There was a very clear adjustment on the wholesale side in early 2013, but it was cast aside toward the end of last year (matching the prior estimates of GDP).

Maybe there is a wealth effect after all, in that inventories are following stock prices rather than anything else. This is not just idle speculation, either, as previous study of the Great Inflation, for example, leading to the eventual adoption of rational expectations theory, more than noticed that inventory was often a primary channel for changing expectations. That made sense in the 1960's and 1970's as changes in expectations for inflation or growth led directly to increasing inventory stockpiles, and thus seemingly marginal economic movement.

Have we regressed backward to that state? The malaise we call the economy now might suggest as much, though at least during the Great Inflation nominal sales were more tightly related, even if ultimately debased. Redistribution then was just that, and that might offer some answers about the lack of real progress now. Orthodox economists see activity for the sake of activity, and thus a plus sign on their GDP spreadsheet. However, redistribution is the opposite of building actual wealth, meaning in this context that inventory is just another misallocation however much it "adds" to GDP.

Whatever the case, any outburst of activity in relation to psychological manipulation through monetary experimentation is, and has been, all too limited. If Bernanke's grand bluff did indeed provoke an inventory response in 2013, it did absolutely nothing by way of "spending leads to more spending." What has been true of autos may also be true of inventory, though that is a much longer leap. As Herb Stein said, this will go on until it can't; and the lack of sales pretty much ensures inventory will keep cycling rather than anything better and greater.