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April 08, 2009
Inventories Coming Down is Bullish
One of the things necessary to turn the GDP numbers is a change in production schedules of factories. At first, all that will occur is a cessation of the cuts in production schedules. This is probably already at work and explains some of the better economic statistics lately. The stats are not signaling growth but they are suggesting stability is seeping albeit at a low level of activity.
Stability in the GDP outlook is the first step required for a higher stock market. I think the rally off the March lowis moslty tied to a feeling that the economy is bottoming. To get another significant leg up will require less negative GDP growth followed by a return to positive growth. The stimulus bill and various Fed and Treasury initiatives will help with this starting in 2Q. Positive GD growth in 4Q is not out of the question. Investors will be hesitant to bid stocks up a lot further, however, until they see sings that economic activity is improving and this is where the low inveotires come in.
My favorite economist, Tony Crescenzi of Miller Tabak, has been hot on the trail of the potential improvement. Here is what he had to say about the inventory numbers:
"The combination of falling inventories and increased sales brought the inventory-to-sales ratio down to 1.31 months from 1.34 in January, although it is still well above the record low of 1.06 months set last June. The decline nonetheless represents progress, and U.S. companies have calibrated their output sufficiently to the new, lower levels of demand.
This shift should begin to reduce the rate of decline in output, although no meaningful increase in output is likely until inventories are brought down significantly more. In other words, the trajectory is changing and it will change enough to perk up a variety of the factory-laden economic calendar, but the magnitude of change is not likely to be large.
A sector that illustrates the evolution of the inventory cycle is the automobile sector. U.S. manufacturers produced vehicles at a 4.3 million annual rate in January and February, well below sales of 6.7 million annualized. In other words, manufacturers have already made the adjustment necessary (we hope) to fit the drop in sales they have experienced. In fact, in this case they have over-adjusted, and if the condition improves, production will have to rise.
As I said, it is the direction of change that will get attention first, via the factory-laden economic calendar. This will rally riskier assets. Later, there will be focus on the magnitude of change and on whether the change in direction is enough to spark a change in the production cycle strong enough to take hold and evolve into a self-reinforcing virtuous cycle of increases in production, income and spending. There will be plenty of obstacles and plenty of doubts."
1Q earnings reports will be a good window on the stability argument. I think the commentary will be mixed, skewing negative. However, the stock market only needs enough of signs of stability to prevent the negative feedback loop and Armageddon scenario from developing again. I am hopeful that there will be enough stability signs which is why I brought down cash balances in Northlake client accounts in late March.
Posted by Steve Birenberg at April 8, 2009 09:56 AM in Stock Market