One Man’s Opinion: Are Inventory Fluctuations Part Of Business Cycles?

Man

The latest headline gross domestic product number might be disappointing, but beyond the visible decline there is positive story as consumer spending was robust and businesses were still investing – albeit at a slower pace than what was witnessed in the second quarter, said Lindsey Piegza, chief economist at Stifel Fixed Income.

The big question, however, remains if the US economy is going to continue the momentum from here as durable goods orders have tumbled after taking a wrong turn and it’s likely to be a struggle now for the economy going forward to maintain current year’s 2 percent growth pace as the year-end approaches, which would be a major concern for the Federal Reserve, she noted.

The third-quarter GDP reading slumped due to the drawdown in inventories, which indicates CEOs are concerned about building up too much stockpiles. Asked why CEOs would be nervous about higher inventories, Lindsey said companies are concerned about the modest gain in consumer spending; annual consumer spending growth now stands at 3 percent and without remarkable gains in hiring along with strong income growth, consumer spending is poised to decline from here.

With inventory build-ups exceeding $100 billion in back-to-back quarters, businesses need to start reducing them because consumer spending is falling short of expectations even though the holiday spending period lies ahead, she observed.

The latest GDP number came in at 1.5 percent, a shade short from the consensus forecast of 1.6 percent. The headline number also gave the impression the Federal Reserve had anticipated a weak reading for the third quarter since the Fed’s statement Wednesday seemed like a downgrade for the economy, although they put the possibility of a rate-hike in December back on the table.

The weak GDP reading was attributed to a slump in inventory and the Fed is aware inventory built-ups tend to overshoot and inventory consolidations tend to undershoot, said David Lebovitz of JP Morgan Asset Management.

The latest GDP number just shows a normal economic cycle with respect to inventories. The Fed has the dual mandate for full employment and price stability, and their full-employment mandate has been met since the unemployment rate has declined from 10 percent to a level of nearly 5 percent today.

The missing piece, however, has been the upward pressure on inflation. The Fed has on record said it understands transitory effects are depressing inflation; i.e. a stronger dollar and lower energy prices, which are also holding-back economic growth right now.

JP Morgan believes as the year-over-year energy price comparisons become more reasonable, inflation is likely to gradually approach the Fed’s 2 percent target sometime during the first quarter of next year. That means a December rate-hike also remains a possibility, he concluded.

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About Ulli Niemann

Ulli Niemann is the publisher of "The ETF Bully" and is a Registered Investment Advisor. Learn more
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