Inventories and the US Economy

Business inventories were on the soft side. Not only was the Jan reading flat, but the Dec series was revised to -0.3% from -0.2%. Jan wholesale and factory inventories had previously been released so the new information today was largely the 0.1% decline in retail inventories.

Inventories added mightily to Q4 09 5.9% annualzed GDP and some what to dismiss the growth because of that. However, a large part of the contraction was also due to inventories. Depsite the adoption of just-in-time inventory management and other practices, the business cycle is still heavily influenced by swings in inventories.

The inventory cycle is still unfolding. The large swing in Q4 still is about the pace of inventory liquidation. It is a gradual process that can be stretched out for the next couple of quarters at least. As sales are increasing (retail sales were up and so are wholesale sales) the inventory to sales ratio is tightening.

Medium term investors should continue to monitor the unfolding inventory story. It will be a key factor in boosting GDP in the coming quarters. A gradual process could help stretch out the impact into H2 when fiscal policy becomes less of a tail wind. While risk on/off seemed like an important driver in the markets last year, our hypothesis is that going forward, growth differentials will be increasingly important.