Thursday, October 15, 2009

Inventory Bottoming

One of the crucial elements in a business cycle is inventory or unsold goods that firms store in the warehouse.
When the economic activity is robust, inventory turnover is high. Goods are flying off shelves. Companies are running down inventory. In order to replenish inventory to meet the demand, companies start producing, hiring workers, ergo the upturn.

In contrast, goods stay on the shelves for way too long when the economic activity is slow. Companies stop producing and freeze hiring while trying to use up the inventory, ergo the downturn.

In short, production will take place as the inventory gets too lean. Obviously, there is no need to produce if there is no sales at all even when the inventory is zero. Therefore, the level of inventory usually is seen in the light of sales, that is inventory-to-sales ratio. It gives the number of month it takes to use up the inventory at the current rate of sales.

What we are seeing now is a level of inventory-to-sales that is close to the recovery period (2002-2003) of the last recession . The total business inventories/sales ratio based on seasonally adjusted data at the end of August was 1.33. [Click on the diagram to enlarge the chart]

I was very quick to see recession looming in the late 2007 . This year, I also find myself optimistic among people I know at this very early stage of recovery, if there is any. Sometimes, what people say does affect my stance. However, at this moment, this piece of inventory data does lend support to optimism of at least a recovery.


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