Rising Inventories Are a Bearish Indicator
(Bloomberg Opinion) -- A big inventory cycle may soon unfold as early holiday gift-buying by U.S. consumers reverses and supplies of goods start to leap.
Retailers have habitually strived for sales growth only to end up with excess inventories that require profit-killing markdowns to unload. This year, supply chain disruptions have taken care of excess inventories. So, casting their normal caution to the wind, retailers have stocked up. Target Corp. and Walmart Inc. both chartered expensive ships to import goods ahead of the holiday season and boosted hiring, at the expense of profit margins.
Target reported a 17.7% rise in inventories from a year earlier in its fiscal third quarter ended Oct. 30, while sales rose less, or 13.2%. Similarly, Walmart had 11.5% more in stock, while sales increased 9.3%, and Home Depot Inc. inventories rose 27.4%, almost three times its sales growth. Without the rise in total private sector inventories in the third quarter, real gross domestic product would have shrunk 0.1% instead of growing 2.1%.
Ample inventories accommodated the 1.7% rise in retail sales in October from September on a seasonally-adjusted basis, double September’s 0.8% gain. Amazon.com Inc. started offering “Black Friday-worthy deals” on Oct. 4, according to the Wall Street Journal, and Target began promoting holiday deals in the first part of October, weeks earlier than in pre-pandemic years.
Surveys sponsored by the National Retail Federation found that 49% of shoppers started their Christmas gift-buying before Thanksgiving, but early buying robbed Thanksgiving weekend activity. Shopping in stores or online between Thursday and Monday totaled 180 million, according to the National Retail Federation, down from 186.4 million in 2020, which was below the 189.6 million in 2019. Online as well as brick-and-mortar sales suffered as online retail sales, $33.9 billion, were down 1.4% from 2020 and the first decline in years, according to data from the Adobe Digital Economy Index).
Excess inventory-building exists beyond retailers. The Bank for International Settlements warns that building precautionary stockpiles of components by some manufacturers might be exacerbating shortages. This creates a false picture of underlying demand. Farm-equipment manufacturer Deere & Co., coming off the just-concluded five-week labor strike, plans to accelerate production to meet robust demand and rebuild inventories. Retail sales volume of high-horsepower tractors and combines are up 23% and 24% this year through October, according to the Association of Equipment Manufacturers, a trade group.
Meanwhile, the computer chip shortage is generating big production increases. Samsung Electronics Co., the world’s largest semiconductor producer by revenue, plans to invest more than $205 billion over the next three years with an emphasis on chips. It recently announced a $17 billion chip-making plant in Taylor, Texas. Taiwan Semiconductor Manufacturing Co. plans to spend over $100 billion in the next three years on new chip factories. Intel Corp. has earmarked over $100 billion for new semiconductor production in the U.S. and Europe over the next decade.
On the supply side, there is growing evidence of supply-chain easing. Ocean freight rates are falling just as U.S. consumers retrench after pre-buying Christmas gifts. Anchored ships laden with retail goods — “floating inventories” — will probably soon be unloaded and trucked to their destinations, adding to inventories. The number of container ships waiting to dock at the Ports of Los Angeles and Long Beach leaped from 9 in mid-June to 71 on Nov. 19, but down from 86 three days earlier, according to the Marine Exchange of Southern California.
Then there are hidden inventories in the form of partially-built vehicles that will hit the market when computer chips arrive to complete them. Excess inventories may already be in consumers’ hands. During the pandemic, stay-at-home Americans bought hordes of goods ranging from TVs to kitchen appliances to bicycles, as durable goods purchases rose 7.7% last year. This year, adjusted for inflation, spending on long-lasting goods fell 26.2% in the third quarter from the second, at annual rates.
It will soon become apparent if consumers’ pre-buying and heavy inventories collide. I suspect that Christmas sales during December may disappoint, forcing heaving discounting and inventory liquidations early in the new year. At the same time, all that floating inventory from China and other Asian countries will arrive, exacerbating the overhang. Also, many hidden inventories may be revealed, adding further to supplies. Economic softness in early 2022 could be exacerbated by the renewed spread of Covid-19.
Economy-crushing inventory cycles are nothing new. After World War I, price and wage controls were removed and pent-up demand and prices exploded. Manufacturers double- and triple-ordered to beat further price increases and shortages. Retailers encouraged consumers to buy ahead in anticipation of further price jumps. Inflationary expectations fed on themselves and created a false sense of robust underlying demand. Prices leaped 24% from the first quarter of 1919 to the second quarter of 1920, according to George A. Gade’s book, “Hand-to-Mouth Buying and the Inventory Situation.” In April 1920, however, the bubble broke and prices dropped 42% to the second quarter of 1921 bottom. Falling prices revealed the false basis for demand, buying dried up and the massive production cuts to liquidate excess inventories resulted in the 1920-1921 recession, the steepest on record. After that bloodbath, inventories were shunned and buying was hand to mouth -- hence the title of Gade’s book.
In the early 1970s, inflation was raging due to huge excess demand created by massive federal outlays for the Vietnam War and Great Society programs. Once again, double- and triple-ordered inventories were delivered and production cuts to liquidate them fueled the 1973-1975 recession, the deepest since the 1930s.
I’m not forecasting a 2022 recession — yet — but excessive inventories are a warning. Huge inventory build-ups that precipitated gigantic cuts in production resulted in the serious recession after World War I and in the early 1970s.
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Gary Shilling is president of A. Gary Shilling & Co., a New Jersey consultancy, a Registered Investment Advisor and author of “The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation.” Some portfolios he manages invest in currencies and commodities.
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