Inventory will stay at targeted levels for most of 2005

Jim Haughey, Director of economics for Reed Business Information -- Industrial Distribution, 12/3/2004

Manufacturing, retail and wholesale inventories have all been moving closely with sales trends since early 2004, with only small month-to-month variation. The steady inventory/sales ratio suggests that inventories are generally balanced across the economy.  No changes are expected in inventory/sales ratios through next summer except for a drop from the current 1.31 ratio for all inventories to at most 1.29, continuing the trend to better inventory management. This is because economic growth is expected to average the same 4 percent annual pace that was achieved over the last few quarters. This is a typical pattern for this stage of the business cycle. Inventory managers have adjusted their stocks and reordering rules to the steady growth stage of the business cycle. 

Inventories at targeted levels will have a neutral impact on prices and delivery times.  However, price inflation will pick up slightly as recent commodity price rises roll through into manufactured products, and delivery lead-times will lengthen marginally with rising capacity utilization in manufacturing. Also, there is risk that inventory may fall below the desired amount briefly, either because of the unusually long delays at West Coast ports or delivery delays due to motor carriers struggling to find enough equipment and drivers. Both of these risks will last for at least a few more months and perhaps for all of 2005.

The current balanced inventories are the calm before the storm. The slowdown in economic growth, from 4 percent to 3 percent expected at the end of next year, will be an even larger turnabout for the flow of goods because goods become a smaller share of the economy at the end of the business expansion. Perfect planning by inventory managers would keep the inventory/sales ratio steady through the period of slower growth. Do not count on this. Inventories will continue to be very volatile at turning points in the business cycle.

The change in days of inventory for all distributors at cyclical turning points is about three days—first a three-day increase over a 6- to 10-month period, then a similar period to get the inventory/sales ratio back to the initial level. The average masks a lot of variation; individual industrial distributors experience a 5- to 10-day swing in days of inventory. Inventory/sales ratios for electronic and machinery components will again experience the most rise and decline in the next inventory cycle.

“A soft landing,” with only a growth slowdown short of a recession, is the current consensus economic outlook. This would start the next inventory cycle—when your overall stock level is too high—next fall. The unwanted pile of inventory would be relatively small and be gone by spring 2006. But it is far too soon to be certain about this forecast. An inventory cycle as ugly as the last one should be expected if economic growth does not slow down noticeably by the end of next year.

Source: Census Bureau
Forecast: Reed Research Group