With a breakout performance by the U.S. economy looking unlikely, business inventories are still running lean—but stimulative policies could provide a boost.
Several indicators suggest reason for some optimism about the U.S. economic outlook. The economy is entering its ninth year of expansion, the third-longest expansion on record so far. The unemployment rate in each month from March through July of this year fell solidly into the range considered indicative of "full employment." And measures of consumer and business confidence remain at or near high-water marks not seen for a decade or more.
Nevertheless, economic growth is still failing to impress. Indeed, this recovery has been rather subpar in terms of real gross domestic product (GDP) growth. From the first quarter of 2010 through the second quarter of 2017, the average annual rate of inflation-adjusted growth of U.S. GDP was just 2.1 percent. By contrast, during similar portions of the previous three expansions, real GDP managed an average annual growth rate of near or above 3.8 percent—substantially stronger than the current anemic figure. Additionally, throughout the recovery following the Great Recession (December 2007-June 2009), the 10-year moving average of real GDP growth has been gradually decreasing rather than seeing a V-shaped rebound.
[Figure 2] Stocks of inventories adjusted for inflationEnlarge this image
Aftermath of the inventory buildup
In spite of a burst of enthusiasm in the global equities and commodities markets after the U.S. election in November 2016, the first quarter of 2017 brought uninspiring news for the "hard" economic indicators (such as strong real GDP growth and rising real wages) that reflect objective, measurable reality. The first quarter's real GDP growth rate managed a paltry 1.2 percent, and the second quarter's 2.6 percent rate was also slightly slower than most analysts expected.
In early 2016, when real GDP growth also appeared to be sputtering, one culprit was a drawdown of inventories by businesses. In general, businesses try to adjust the supply of goods on hand to match anticipated demand levels. A buildup of inventories, such as is often seen during recessions, can be a function of an unanticipated demand shortfall. But the inventory buildup that started in 2014, although unwanted, was not caused by a sudden drop-off in domestic demand, but rather by a "perfect storm" of other factors. These included a strong U.S. dollar, which decreased the competitiveness of U.S. exports abroad; a decline in global oil and commodity prices, which reduced spending on equipment and structures in the energy industry; and labor disruptions affecting ports on the U.S. West Coast, which interrupted the flow of goods and caused a glut of supply when it was finally resolved in late February 2015. As businesses worked through this inventory overstock, the slowing inventory investment subtracted between 0.2 and 0.7 percentage points from real GDP growth for five consecutive quarters through the second quarter of 2016.
Once the inventory drawdown was over, businesses remained cautious about reinvesting in inventories. Rather than resuming an upward trend, gross stocks of inventories for retailers, wholesalers, and manufacturers stayed roughly flat—and even declined in the first quarter of 2017, knocking around 1.5 percent off of real GDP growth. In general, retailers are better able to adapt to unexpected changes in inventory levels than are wholesalers or manufacturers—a pattern reflected in the stability of the inventory-to-sales ratios for these sectors. From its peak to its lowest subsequent point, the ratio of inventories to sales fell 2.7 percent for the retail sector, compared with 5.9 percent for wholesalers and 4.2 percent for manufacturers. One notable exception was auto dealers, which have been having trouble moving cars off lots. But most businesses are running leaner; inventory-to-sales ratios remain substantially lower than they were at their early-2016 peaks. (See Figure 1.)
A major reason why businesses have been slow to build up inventories is fierce competition, which has led to tight margins and price discounting. As American manufacturers are increasingly forced to cut costs to compete, the price of goods has declined. And although headline U.S. price inflation continues to creep up, this disguises the fact that there are really two types of consumer price inflation at work: goods and services. The price of services continues to grow at a brisk clip—between 2.2 and 3.2 percent in year-on-year terms during the last five years—while the index of the price of core commodities has been solidly in the negative in every quarter since the second quarter of 2013. During the second quarter of 2017, the index of core commodities prices posted its largest year-on-year decline (0.7 percent) since 2007.
With goods prices contracting, businesses are painfully aware that any inventory sitting on shelves is producing a loss. The increased cost of holding inventories ramps up the pressure to minimize their inventory stocks. Indeed, during the inventory buildup of 2014-2015, this effect was enough to produce a noticeable impact on corporate profits.
The growth of the digital economy is also squeezing inventory accumulation, particularly for retailers. E-commerce retail sales are on a tear, gobbling up market share from brick-and-mortar establishments at an impressive rate. In the second quarter of 2017, e-commerce retail sales grew 16.2 percent year-on-year, making up 8.9 percent of total retail trade (total retail sales less restaurants), and it has grown by a yearly rate of at least 12.8 percent since the fourth quarter of 2009. Meanwhile, sales at department stores are dwindling. As digital retailers need to maintain less inventory to ensure that demand can be satisfied, e-commerce has become another source of downward pressure on retailers' inventories.
The inventory outlook
The outlook for inventory investment, which reflects that of both the U.S. and global economies, is generally positive. IHS Markit expects real GDP to increase at annual rates of around 3.1 percent in the third quarter of this year and 2.4 percent in the fourth. Growth will be broadly based, with solid gains in consumer spending, residential investment, business fixed investment, and exports. Consumer spending will remain an engine of U.S. economic growth, supported by still-impressive levels of consumer confidence and by rising employment, real disposable incomes, and household wealth. Record levels of household net worth will spark strong growth in spending on durable goods.
After stalling in 2016, capital spending revived in the first half of 2017. Expanding global markets, relatively low financing costs, an improving regulatory climate, and the resurgence in the U.S. domestic oil industry are driving an upturn in investment. Business fixed investment saw its strongest jump since mid-2014 during the first quarter, boosted by over-the-top real spending growth on mines and wells (up a whopping annualized 272 percent).
International trends are also supportive of inventory development. Although the broad-based dollar exchange-rate index increased by about 5 percent between the November election and the end of 2016, it has since lost those gains, and the dollar has further to fall. It will likely lose ground as business cycles in other economies catch up with the United States—which should give U.S. exports a second wind. And after giving back their gains of the Trump rally, global commodity prices now appear to be situated on a stable foundation.
There is considerably greater uncertainty regarding the U.S. growth outlook for 2018, which will depend on the nature of policies coming out of Washington. The Trump administration and the Republican-led Congress have expressed their intention to cut corporate taxes, reduce personal income taxes, remove regulations, and introduce more pro-growth policies. In spite of political turbulence and continued setbacks to parts of this reform agenda, the IHS Markit view is that modest fiscal stimulus (personal and corporate tax cuts, along with a boost in infrastructure spending) is still possible. If carried out, it will help real GDP growth to accelerate to 2.7 percent next year. As a function of this quickened growth pace, we forecast inventory investment to pick up, with retailers adding 1.9 percent to their inventories between the fourth quarters of 2017 and 2018, and wholesale inventories adding 1.3 percent. (See Figure 2.) However, if stimulus is not forthcoming, we estimate that real GDP growth will be approximately 0.4 percentage points lower in 2018, when the full impact of such stimulus would likely be felt.
The good news is that the fundamentals of the U.S. economy remain solid enough that, even without any stimulus, it can amble along at a decent pace for the next year or two—and inventories should go along for the ride.
Container imports at U.S. ports are seeing another busy month as retailers and manufacturers hustle to get their orders into the country ahead of a potential labor strike that could stop operations at East Coast and Gulf Coast ports as soon as October 1.
Less than two weeks from now, the existing contract between the International Longshoremen’s Association (ILA) and the United States Maritime Alliance covering East and Gulf Coast ports is set to expire. With negotiations hung up on issues like wages and automation, the ILA has threatened to put its 85,000 members on strike if a new contract is not reached by then, prompting business groups like the National Retail Federation (NRF) to call for both sides to reach an agreement.
But until such an agreement is reached, importers are playing it safe and accelerating their plans. “Import levels are being impacted by concerns about the potential East and Gulf Coast port strike,” Hackett Associates Founder Ben Hackett said in a release. “This has caused some cargo owners to bring forward shipments, bumping up June-through-September imports. In addition, some importers are weighing the decision to bring forward some goods, particularly from China, that could be impacted by rising tariffs following the election.”
The stakes are high, since a potential strike would come at a sensitive time when businesses are already facing other global supply chain disruptions, according to FourKites’ Mike DeAngelis, senior director of international solutions. “We're facing a perfect storm — with the Red Sea disruptions preventing normal access to the Suez Canal and the Panama Canal’s still-reduced capacity, an ILA strike would effectively choke off major arteries of global trade,” DeAngelis said in a statement.
Although West Coast and Canadian ports would see a surge in traffic if the strike occurs, they cannot absorb all the volume from the East and Gulf Coast ports. And the influx of freight there could cause weeks, if not months-long backlogs, even after the strikes end, reshaping shipping patterns well into 2025, DeAngelis said.
With an eye on those consequences, importers are also looking at more creative contingency plans, such as turning to air freight, west coast ports, or intermodal combinations of rail and truck modes, according to less than truckload (LTL) carrier Averitt Express.
“While some importers and exporters have already rerouted shipments to West Coast ports or delayed shipping altogether, there are still significant volumes of cargo en route to the East and Gulf Coast ports that cannot be rerouted. Unfortunately, once cargo is on a vessel, it becomes virtually impossible to change its destination, leaving shippers with limited options for those shipments,” Averitt said in a release.
However, one silver lining for coping with a potential strike is that prevailing global supply chain turbulence has already prompted many U.S. companies to stock up for bad weather, said Christian Roeloffs, co-founder and CEO of Container xChange.
"While the threat of strikes looms large, it’s important to note that U.S. inventories are currently strong due to the pulling forward of orders earlier this year to avoid existing disruptions. This stockpile will act as an essential buffer, mitigating the risk of container rates spiking dramatically due to the strikes,” Roeloffs said.
In addition, forecasts for a fairly modest winter peak shopping season could take the edge off the impact of a strike. “With no significant signs of peak season demand strengthening, these strikes might not have as intense an impact as historically seen. However, the overall impact will largely depend on the duration of the strikes, with prolonged disruptions having the potential to intensify the implications for supply chains, leading to more pronounced bottlenecks and greater challenges in container availability, " he said.
A coalition of freight transport and cargo handling organizations is calling on countries to honor their existing resolutions to report the results of national container inspection programs, and for the International Maritime Organization (IMO) to publish those results.
Those two steps would help improve safety in the carriage of goods by sea, according to the Cargo Integrity Group (CIG), which is a is a partnership of industry associations seeking to raise awareness and greater uptake of the IMO/ILO/UNECE Code of Practice for Packing of Cargo Transport Units (2014) – often referred to as CTU Code.
According to the Cargo Integrity Group, member governments of the IMO adopted resolutions more than 20 years ago agreeing to conduct routine inspections of freight containers and the cargoes packed in them. But less than 5% of 167 national administrations covered by the agreement are regularly submitting the results of their inspections to IMO in publicly available form.
The low numbers of reports means that insufficient data is available for IMO or industry to draw reliable conclusions, fundamentally undermining their efforts to improve the safety and sustainability of shipments by sea, CIG said.
Meanwhile, the dangers posed by poorly packed, mis-handled, or mis-declared containerized shipments has been demonstrated again recently in a series of fires and explosions aboard container ships. Whilst the precise circumstances of those incidents remain under investigation, the Cargo Integrity Group says it is concerned that measures already in place to help identify possible weaknesses are not being fully implemented and that opportunities for improving compliance standards are being missed.
By the numbers, overall retail sales in August were up 0.1% seasonally adjusted month over month and up 2.1% unadjusted year over year. That compared with increases of 1.1% month over month and 2.9% year over year in July.
August’s core retail sales as defined by NRF — based on the Census data but excluding automobile dealers, gasoline stations and restaurants — were up 0.3% seasonally adjusted month over month and up 3.3% unadjusted year over year. Core retail sales were up 3.4% year over year for the first eight months of the year, in line with NRF’s forecast for 2024 retail sales to grow between 2.5% and 3.5% over 2023.
“These numbers show the continued resiliency of the American consumer,” NRF Chief Economist Jack Kleinhenz said in a release. “While sales growth decelerated from last month’s pace, there is little hint of consumer spending unraveling. Households have the underpinnings to spend as recent wage gains have outpaced inflation even though payroll growth saw a slowdown in July and August. Easing inflation is providing added spending capacity to cost-weary shoppers and the interest rate cuts expected to come from the Fed should help create a more positive environment for consumers in the future.”
The U.S., U.K., and Australia will strengthen supply chain resiliency by sharing data and taking joint actions under the terms of a pact signed last week, the three nations said.
The agreement creates a “Supply Chain Resilience Cooperation Group” designed to build resilience in priority supply chains and to enhance the members’ mutual ability to identify and address risks, threats, and disruptions, according to the U.K.’s Department for Business and Trade.
One of the top priorities for the new group is developing an early warning pilot focused on the telecommunications supply chain, which is essential for the three countries’ global, digitized economies, they said. By identifying and monitoring disruption risks to the telecommunications supply chain, this pilot will enhance all three countries’ knowledge of relevant vulnerabilities, criticality, and residual risks. It will also develop procedures for sharing this information and responding cooperatively to disruptions.
According to the U.S. Department of Homeland Security (DHS), the group chose that sector because telecommunications infrastructure is vital to the distribution of public safety information, emergency services, and the day to day lives of many citizens. For example, undersea fiberoptic cables carry over 95% of transoceanic data traffic without which smartphones, financial networks, and communications systems would cease to function reliably.
“The resilience of our critical supply chains is a homeland security and economic security imperative,” Secretary of Homeland Security Alejandro N. Mayorkas said in a release. “Collaboration with international partners allows us to anticipate and mitigate disruptions before they occur. Our new U.S.-U.K.-Australia Supply Chain Resilience Cooperation Group will help ensure that our communities continue to have the essential goods and services they need, when they need them.”
A new survey finds a disconnect in organizations’ approach to maintenance, repair, and operations (MRO), as specialists call for greater focus than executives are providing, according to a report from Verusen, a provider of inventory optimization software.
Nearly three-quarters (71%) of the 250 procurement and operations leaders surveyed think MRO procurement/operations should be treated as a strategic initiative for continuous improvement and a potential innovation source. However, just over half (58%) of respondents note that MRO procurement/operations are treated as strategic organizational initiatives.
That result comes from “Future Strategies for MRO Inventory Optimization,” a survey produced by Atlanta-based Verusen along with WBR Insights and ProcureCon MRO.
Balancing MRO working capital and risk has become increasingly important as large asset-intensive industries such as oil and gas, mining, energy and utilities, resources, and heavy manufacturing seek solutions to optimize their MRO inventories, spend, and risk with deeper intelligence. Roughly half of organizations need to take a risk-based approach, as the survey found that 46% of organizations do not include asset criticality (spare parts deemed the most critical to continuous operations) in their materials planning process.
“Rather than merely seeing the MRO function as a necessary project or cost, businesses now see it as a mission-critical deliverable, and companies are more apt to explore new methods and technologies, including AI, to enhance this capability and drive innovation,” Scott Matthews, CEO of Verusen, said in a release. “This is because improving MRO, while addressing asset criticality, delivers tangible results by removing risk and expense from procurement initiatives.”
Survey respondents expressed specific challenges with product data inconsistencies and inaccuracies from different systems and sources. A lack of standardized data formats and incomplete information hampers efficient inventory management. The problem is further compounded by the complexity of integrating legacy systems with modern data management, leading to fragmented/siloed data. Centralizing inventory management and optimizing procurement without standardized product data is especially challenging.
In fact, only 39% of survey respondents report full data uniformity across all materials, and many respondents do not regularly review asset criticality, which adds to the challenges.