by Asset Allocation Committee | PDF

Of all the different economic indicators published by the government and private entities, one of the least followed, but potentially very enlightening, is the Census Bureau’s monthly report on business inventories.  The report tracks the value of inventories on hand each month at the retail, wholesale, and manufacturing levels and compares those values to the amount of sales at each level.  The resulting inventory/sales ratio can help us predict business behavior in the coming months.  For example, if the inventory/sales ratio is higher than normal, it may mean firms are saddled with excess stockpiles and will cut prices or hold back on new orders to their suppliers.  When the inventory/sales ratio is lower than normal, it could portend increased orders and higher prices.  The inventory/sales ratio fluctuates over time because of changes in technology and management practices, but it can still provide important insights over the short term.

As shown by the heavy blue line in the chart below, the overall inventory/sales ratio fluctuated between about 1.35 and 1.40 during the five years leading up to the coronavirus pandemic.  When the pandemic shutdowns hit, many firms saw their sales plummet, leaving their inventories sitting on shelves in their shuttered stores or warehouses.  The overall inventory/sales ratio surged to 1.67 in April.  With the recent reopening of most of the economy, however, the overall ratio has now fallen to 1.33.  Since the current ratio is lower than in the recent past, it may suggest firms would be eager to rebuild their stockpiles if they became more confident that the economic recovery will continue.  Lean inventories may also encourage price hikes or discourage price cuts, helping to alleviate fears of excessively low inflation.

A close look at the detail in the chart is even more encouraging.  Note that before the pandemic, retailers typically carried $1.45 to $1.50 of inventory for every dollar of monthly sales.  In August, however, retailers had just $1.24 of inventory for every dollar of sales, marking their lowest inventory/sales ratio in at least 25 years.  If you’ve finally started to go out shopping again after the lockdowns, you may have noticed that many stores have very little inventory on their shelves.  In part, that may reflect retail managers’ lack of confidence in future demand.  It could also be partly unplanned, reflecting an inability to get new inventories because of supply chain disruptions or reduced financing by skeptical lenders.  In any case, it’s hard to believe retailers would keep their stockpiles this low when the economy returns to normal.  Rather, one would expect an eventual inventory restocking and strongly rebounding orders.

In contrast with the situation for retailers, factory inventories are a bit high compared with recent history.  Rather than carrying inventories worth $1.38 to $1.40 per dollar of sales, as they did before the pandemic, manufacturers recently had about $1.43 of inventory per dollar of sales.  That means that if retail restocking leads to a rebound in manufacturing orders, there could be a modest delay in new production (since the wholesale inventory/sales ratio is right at its recent average, we are ignoring it for purposes of this analysis).  All the same, it probably wouldn’t take long for the small excess in factory stockpiles to get used up.  Manufacturers and raw material suppliers might need to ramp up production quickly, which in turn could require faster hiring.  It’s probably too much to say the economy is a coiled spring ready to snap back to normal.  We still think it will take some time to get over the drag from the pandemic.  All the same, even a gradual normalization process could produce a big acceleration in factory activity, helping boost corporate profits and supporting further stock market gains.

View PDF

by Asset Allocation Committee | PDF

Later this month, the European Union will begin auctioning off bonds to facilitate its economic recovery from the pandemic. In all, the EU plans to raise up to €850 billion over the next 5-7 years, with €750 billion still awaiting approval from the European Parliament. If approved, as we expect, the funds will be backed by the full faith and credit of the European Union members and will come in two parts, the Support to mitigate Unemployment Risks in an Emergency (SURE) program and the Next Generation EU (NGEU) program.

The latter will be aimed disproportionately at supporting the most vulnerable and indebted countries within the union such as Greece, Italy, Portugal, and Spain (GIPS). If successful, this program could provide these countries with a needed boost in consumption and income, something these countries have lacked since the start of the financial crisis.

Over the past few years, the GIPS countries were forced to run an export-focused growth model to help repay loans from their respective bailout agreements. This reliance on exports allowed GIPS to boost their internal savings, which made these countries more solvent. However, despite the improvement in internal savings, the removal of labor protections, fiscal protections, and higher taxes in these countries led to deteriorating living conditions and strained public spending. As a result, prior to the pandemic most of these countries were, by design, growing slowly.

In addition, by having an export-focused growth model, GIPS were sensitive to shocks to the global economy. When the pandemic hit, international travel and global trade collapsed. Lockdown and travel restrictions decimated tourism, which provides a significant source of revenue for these countries, and halted production of manufactured goods. Additionally, the drop in world growth has stunted the demand for global exports. Although the world economy has started to recover, it is unclear when global trade and travel will normalize.

With citizens unwilling to undergo additional austerity and GIPS lacking monetary independence, the recovery fund will likely ease some political angst, which has led to increasing populism in Europe. Even before the pandemic, GIPS were struggling to find ways to appease their citizens who have grown tired of constrained growth. In fact, it is possible that if the EU didn’t ease some of its restraints some of these countries would have withdrawn from the EU and the Eurozone. Fears of political unrest that could undermine the integrity of the EU led the richer northern European nations to agree to the bailout package.

This new spending will allow these countries to boost investment in infrastructure projects, healthcare, and digital technology. Additionally, the fund has also set aside money to invest in green technology. Given the lack of consumption over the past few years due to the restrictions of deficit, these countries have been limited in their ability to invest in their respective economies. The €750 billion of funds, of which €390 billion will be used as grants, will likely provide a notable boost in GDP.

The funds are expected to be disbursed in 2021 and in 2022. In the meantime, countries have access to the €100 billion SURE program to help support local businesses and provide unemployment benefits. That being said, assuming the money from the recovery fund is used wisely, we expect the stimulus could make European equities attractive as we believe that years of austerity have led to a lot of pent-up demand in the GIPS countries. As a result, consumer discretionary and real estate could be of some interest.

View PDF