Standard Chartered’s latest research on the US by John Calverley and David Semmens alludes to an interesting point. The drop in Q4 GDP was only less than expected because sales fell faster than businesses could cut output.
This, unsurprisingly, has led to a significant rise in inventories, which must go down before businesses can even think about stopping job cuts or orders. It’s also the reason why Asian exports to the US have fallen so disastrously. Accordingly, however, it makes for a pretty insightful indicator. Note the chart below:
As the analysts explain (our emphasis):
The sudden slump in demand in the second half of 2008 began before the Lehman bankruptcy but accelerated rapidly in Q4. As a result inventory/sales ratios have moved up sharply, triggering major new cutbacks in orders in the retail, wholesale and manufacturing sectors. It is this which has reverberated back up the supply chain, causing eye-watering drops in Asian exports and pulling down industrial commodity prices.
Total US consumer spending fell about 2% in real terms (not annualised) in the second half of last year yet Taiwan?s exports were down 42% in December and Korea?s were down 33% in January. These big declines are due in part to lower prices and in part to the fact that consumers cut back on items that can easily be delayed when times are uncertain such as cars, flat screen TVs and cell phones, all items with a high import content. But they also reflect the need to cut back inventories. Once inventories are back in line with sales, orders will improve.
But, despite the cutbacks in orders, US GDP data suggest that inventories still rose slightly in Q4. Since inventories fell in Q3 the effect was to add 1.3% to Q4 GDP in contrast to the subtraction we expected. It is possible that Q4 inventories will be revised lower when the government has more data. But meanwhile we have increased our estimate for the decline in Q1 GDP to -6%, (seasonally adjusted annual rate) expecting the major part of the inventory correction to occur this quarter. Meanwhile companies will continue to cut back production and jobs until they have worked inventories down.
As Standard Chartered conclude, the inventory adjustment will likely be achieved before any other turnaround and it is this which allow US GDP to move back into positive territory. They expect the economy to do so by the end of the year after several quarters of decline. In the interim, careful monitoring of inventories and new orders is going to be critical.