A quick look at a timely topic of interest – with a brief review of why it could matter to investors.

Chart of the Week
2 Likes

March 23, 2015

Inventories: less can be more
Manufacturing & Trade Inventory-to-Sales Ratio: Dec 1980 – Dec 2014

chart

Source: Census Bureau via Bloomberg, as of 1/31/2015. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

The bottom line:

  • The initial estimate of US GDP growth for 4Q14 was recently revised downward, from 2.6% to 2.2% – not especially encouraging for investors hoping for further pickup in economic activity.
  • However, that downward revision can be attributed in part to lower levels of inventory accumulation than were assumed in the previous estimate – which does have positive implications for continued future growth.
  • Why? If inventories were to grow too large, production would need to be cut until excess inventory is worked through. If those cutbacks were significant, then overall growth could slow abruptly.
  • Contrast that with a more modest inventory build-up – one that would allow companies to carry on production even if there's a temporary falloff.
  • That might allow companies to weather a temporary slowdown in demand – which is how some are interpreting the recent slowing in retail sales, durable goods orders and the ISM's Purchasing Managers Index for manufacturing.¹
  • In the past, big swings in inventories were a major factor contributing to "boom & bust" periods in the American economy. However, the introduction of new technologies that allow for better monitoring and control of inventory levels has helped moderate that.
  • For example, there have been three official recessions averaging 11.1 months in length since 1990—a period that arguably covers the widespread introduction of inventory control technologies. Contrast that to the period between post WWII era until 1990, when there were eight recessions, averaging 18.2 months in length.²

The chart:

  • The chart above shows the inventory-to-sales ratio from the Census Bureau's Manufacturing & Trade Inventory and Sales series, which compiles data from the wholesale and retail sectors of the economy.
  • The inventory-to-sales ratio measures the number of months it would take businesses to deplete their shelves if the pace of sales remained constant.
  • The ratio was in general decline from the 1980s until the early 2000's; for that quarter century the ratio averaged about 1.5 months.
  • Since then it has stabilized, averaging just below 1.3 months over the past decade—even including the spike during the recession of 2008-2009 (not a typical recession).
  • In January, the I/S ratio was 1.35 months, above the 10-year average and the highest since July 2009.

 

¹ Source: Bloomberg. Retail sales declined on a month over month basis in December, January and February. In January 2015 (the latest available), durable goods orders, excluding the more volatile transportation orders, were 3.3% below their peak of September 2014. Including transportation orders, they were 2.1% below the July 2014 peak. The ISM PMI slowed to 52.5% in February from 52.9% in January, which was a decline from 57.8% in December.

² Source: National Bureau of Economic Research, US Business Cycle Expansions and Contractions


Definitions:

Gross Domestic Product ("GDP") is an economic statistic which measures the market value of all final goods and services produced within a country in a given period of time.

The Manufacturing and Trade Inventory and Sales estimates are based on data from three surveys: the Monthly Retail Trade Survey, the Monthly Wholesale Trade Survey, and the Manufacturers' Shipments, Inventories, and Orders Survey.

The Institute for Supply Management's (ISM) Purchasing Managers Index (PMI) for the US manufacturing sector measures sentiment based on survey data collected from a representative panel of manufacturing and services firms. PMI levels greater than 50 indicate expansion; below 50, contraction.

The Institute for Supply Management (ISM) is an association representing more than 48,000 purchasing and supply management professionals. It conducts regular surveys of purchasing and supply managers to determine industry trends.


IMPORTANT INFORMATION:

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, or a guarantee of future results, or investment advice.

This material is for information only and does not constitute an invitation to the public to invest in any funds, securities, strategies or other products. You should be aware that the investment opportunities described should normally be regarded as longer term investments and they may not be suitable for everyone. All investments involve risk, including possible loss of principal. The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Past performance is no guide to future returns and may not be repeated. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested. Unless otherwise noted the "$" (dollar sign) represents U.S. Dollars.

Please note that an investor cannot invest directly in an index. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed and is not a complete summary or statement of all available data. Individual securities mentioned are intended as examples of portfolio holdings and are not intended as buy or sell recommendations. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not take into account the particular investment objectives, financial situation or needs of individual investors.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, or a guarantee of future results, or investment advice. The information in this material is confidential and proprietary and may not be used other than by the intended user. Neither Legg Mason or its affiliates or any of their officer or employee of Legg Mason accepts any liability whatsoever for any loss arising from any use of this material or its contents. This material may not be reproduced, distributed or published without prior written permission from Legg Mason. Distribution of this material may be restricted in certain jurisdictions. Any persons coming into possession of this material should seek advice for details of, and observe such restrictions (if any).

This material may have been prepared by an advisor or entity affiliated with an entity mentioned below through common control and ownership by Legg Mason, Inc.

This material is only for distribution in those countries and to those recipients listed.

All investors in the UK, professional clients and eligible counterparties in EU and EEA countries ex UK and Qualified Investors in Switzerland
Issued and approved by Legg Mason Investments (Europe) Limited, registered office 201 Bishopsgate, London EC2M 3AB. Registered in England and Wales, Company No. 1732037. Authorized and regulated by the Financial Conduct Authority. Client Services +44 (0)207 070 7444.

All Investors in Hong Kong and Singapore:
This material is provided by Legg Mason Asset Management Hong Kong Limited in Hong Kong and Legg Mason Asset Management Singapore Pte. Limited (Registration Number (UEN): 200007942R) in Singapore.

This material has not been reviewed by any regulatory authority in Hong Kong or Singapore.

Qualified domestic institutional investors in the People's Republic of China (PRC), Distributors and existing investors in Korea and Distributors in Taiwan:
This material is provided by Legg Mason Asset Management Hong Kong Limited to eligible recipients in the PRC and Korea and by Legg Mason Investments (Taiwan) Limited (Registration Number: (98) Jin Guan Tou Gu Xin Zi Di 001; Address: Suite E, 55F, Taipei 101 Tower, 7, Xin Yi Road, Section 5, Taipei 110, Taiwan, R.O.C.; Tel: (886) 2-8722 1666) in Taiwan. Legg Mason Investments (Taiwan) Limited operates and manages its business independently.

This material has not been reviewed by any regulatory authority in the PRC, Korea or Taiwan.

All Investors in the Americas:
This material is provided by Legg Mason Investor Services LLC, a U.S. registered Broker-Dealer, which may include Legg Mason International - Americas Offshore. Legg Mason Investor Services, LLC, Member FINRA/SIPC, and all entities mentioned are subsidiaries of Legg Mason, Inc.

All Investors in Australia:
This material is issued by Legg Mason Asset Management Australia Limited (ABN 76 004 835 839, AFSL 204827) ("Legg Mason"). The contents are proprietary and confidential and intended solely for the use of Legg Mason and the clients or prospective clients to whom it has been delivered. It is not to be reproduced or distributed to any other person except to the client's professional advisers.

FN1511147

Previous Editions

Click on a date to view that week's edition of charts.

Poll

Will the current wave of central bank easing jump-start the world's economies?








Poll

Will the current wave of central bank easing jump-start the world's economies?

No - The real issues are structural - real progress on labor reform and regulatory excess will have more impact
(29%)
No - Deflation is already taking hold, making monetary policy changes ineffective
(4%)
Yes - The US model shows that monetary easing can help economies heal in the medium term
(15%)
Yes, but it will take even  longer than it did in the US, and the delay will have a negative political impact
(52%)



Previous month Poll

What would be the best news for markets for the remainder of the year?

Strong US corporate earnings validate US economic expansion
(33%)
Strength in the US dollar convinces the Fed to keep short rates low longer
(9%)
European Central Bank bond buying rekindles growth in European Union countries
(45%)
Growth in China strong enough to leave room for financial system and structural reform
(13%)