Surprise Inventory Builds Outpace Sales: Will Q4 Production Slow?

Source: http://www.flickr.com/photos/teegardin/

Source: http://www.flickr.com/photos/teegardin/

Total business sales — the combined dollar value of trade sales and manufacturers’ shipments — increased a seasonally adjusted 0.5 percent to $1.3 trillion in September, according to data released by the U.S. Census Bureau on Thursday. This compares against an inventory build of 0.7 percent to $1.7 trillion, growth that exceeded economist expectations of 0.3 percent but still not quite high enough to materially affect the total business inventories-to-sales ratio, which remained unchanged at 1.29.

The data are somewhat surprising but it’s unclear if concern is warranted. A pre-holiday season inventory build is expected, and the data are likely to reflect it in some way despite seasonal adjustment, and the larger-than-expected build in September was fairly well balanced by strong sales. In fact, sales are up 3.9 percent on the year while inventories are up 3.6 percent. The September inventory-to-sales ratio of 1.29 is actually below the year-ago level of 1.30, suggesting a slightly higher future production demand this year than last.

Economists and market participants can use the inventory-to-sales ratio to determine whether production will increase or decrease in the coming months. Production generally slows as inventories rise and firms need to work down the build, and production increases as inventory declines as firms work to avoid shortages.

Wednesday’s total business sales and inventory data follow wholesale sales and inventory data for October, which were released on Tuesday. The wholesale data showed a 1 percent climb in sales and a 1.8 percent inventory build on the month, but the inventory-to-sales ratio was effectively unchanged, at 1.18.

Wholesale trade data can be useful to investors who want to gain some insight into consumer shopping behavior. Having an idea of whether production is likely to increase or decrease in the future — by looking at the inventory-to-sales ratio — investors can develop a better picture of the economic and business landscape against which they have to make decisions.

Corporate profits naturally increase when production increases (that is, when sales increase and inventories need to build to keep up). When inventories build faster than sales, though, this can foreshadow a slowdown in production. The total business sales and inventory data provide a more complete but less timely picture of economic and business conditions.

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