Inventories Continue To Fall

Business inventories fell 1.2% in February, the sixth straight monthly decline and a cumulative decline of about 5.8% or $89 billion. Sales increased by 0.2%.

The six-month dip appears to be the largest percentage decline of the past 50 years and will help sow the seeds for stabilization in industrial output and the overall economy.

The combination of falling inventories and increased sales brought the inventory-to-sales ratio down to 1.43 months from 1.45 in January, although it is still well above the record low of 1.23 months set last June. The decline nonetheless represents progress: U.S. companies have calibrated their output sufficiently to the new, lower levels of demand.

This 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.

Manufacturers seem to have already made the necessary adjustment to fit the drop in sales. In fact, they have overadjusted and, if conditions stay the same, production will have to rise.

The direction of change 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.

And yes, there will be plenty of obstacles and plenty of doubts.