Scary Inventories

I’m not prone to overly worry about every month new release, but the inventory situation is a bit troubling.

This could prove temporary–look at the January 2004 dip–but it could also cause significant trouble.  Companies typically cut back their orders when inventories are above target, which feeds through wholesalers to manufacturers of finished products to manufacturers of raw and intermediate materials.  (Example: a cutback on car orders causes a cutback of orders for rolled steel, causing a cutback in orders for iron ore or steel scrap.  Some industries have even more steps in the production process.)

Big inventory corrections are usually associated with recessions.  An inventory run-up would precede a draw-down of inventories.  What we’d like to see is inventories on a smooth steady trend.  (Incidentally, the long-run trend is toward lower Inventory-sales ratios, so the decline in the chart from early 2003 through early 2006 is normal trend.)

Business Strategy Implications: Make sure you’ve done your contingency planning, and watch your early warning system.  If you are in business with inventories, monitor yours very closely, and stay in close touch with your customers.