Business inventories represent both an indicator of things to come and a reflection of the recent past. As a result, they're often cited as the best of indicators, as well as the worst. It takes a two-handed economist to make this type of statement: On one hand…and on the other hand.....
Inventory to sales ratios (I/S) represent the number of months of sales that are currently held in inventory and are based on the current month's sales. The overall inventory-to-sales ratio is a measure of sales and inventories in manufacturing, retail and wholesale sectors combined. That ratio has remained virtually unchanged since last July. Currently, the economy holds approximately 1.3 months of current sales in inventory.
If the I/S ratio were a good indicator, then the economy would have been flat for the last eight months, which it was not. Once again, the devil is in the details — and this time the news is not bad.
During February, the overall index increased by less than 0.8 of a percent. However, although the three underlying I/S ratios changed, they did not all change in the same direction. The manufacturers' index and the wholesalers' index were both up, while the retailers' index was down.
When March numbers are released, I expect we'll see increases in both the retailers' index and the wholesalers' index, while the manufacturers' index remains unchanged. The overall index is likely to rise again slightly.
Giving today's numbers some historical perspective, the overall index is about 15% to 20% below where it was in the early 1990s (1.6).
Today, consumption amounts to about $8 trillion a year, or $667 billion a month. At an I/S ratio of 1.6 (early-1990s level), we would need $1.07 trillion dollars in inventory. At today's ratio of 1.3, the inventory requirement falls to $0.87 trillion, or a decline in inventory investment of $200 billion. We can disagree about the specific ratios, but the overall investment reduction will not be radically changed. Consequently, our final market for goods is less expensive.
The good news is that our distribution system is much more efficient than ever before. Changes in demand translate much more quickly to changes at the production and wholesale levels. Imported goods also respond more quickly to changes in demand than in the past. As a result, economic swings are now more muted.
The bad news is that we may have become more vulnerable to other economic concerns. Since inventories adjust rapidly to demand, we need to understand how consumers will react.
Economists who also consider themselves behaviorists tend to look at the economy in terms of adjustments to consumer behavior based on current information, ultimately leading to expectations about the future.
Some suggest that we're capable of absorbing information on the fly, and that in general we make rational decisions about future investments and purchases. If this is indeed true, then we should expect the economy to waffle along for a while.
But every day we're bombarded with pundits offering their insights into markets and economic activity. This leads to information anxiety, which can result in confusion and withdrawal. As individuals and businesses reign in expectations and minimize risk exposure, economic growth begins to slow. It's a standard response to uncertainty.
So I think we can expect slower than optimal growth as consumers and investors knee-jerk their way into the market. For now, however, manufacturers are keenly sniffing the winds of monthly sales as economic growth continues.