The Inventory Effect

Gus J. Bourgeois, III

July 30, 2010

U.S. Gross Domestic Product (GDP) was recently revised downward from a seasonally adjusted annual rate of 3.0% to 2.7% for the first quarter of 2010. Standing alone, this is sobering news for the U.S. economy, after an encouraging 5.6% reading during the fourth quarter of 2009. But this reduction has particular relevance to the transportation and logistics industry.

Looking behind the numbers that make up the downward revision for the first quarter of 2010, Tim Lacono, founder of the investment website Lacono Research, notes that “[t]he change for the first quarter was a result of downward revisions to personal consumption and net exports that more than offset upward revisions to inventory, which has been the primary driver for the U.S. economy since last summer.”

That statement reflects two important points: first, one of the primary economic drivers of the U.S. economy in the last year has been the rise in inventories (which has obviously been very beneficial to the transportation and logistics industry). That fact shouldn’t be surprising, considering the prolonged drop in inventory levels witnessed during the Great Recession — at some point, businesses deplete their inventories to “bare-bones” levels, and are forced to replenish or go out of business. This is a normal part of the “end-of-recession” cycle, and is generally followed by an increase in personal consumption and net exports, as the roots of the economic rebound take hold and consumer confidence increases —  which feeds and extends the cycle of recovery and expansion, and returns transportation and logistics activities to more normal levels.

But Lacona notes that for the first quarter of 2010, “[t]he change in inventories alone accounted for a full 1.75 percentage points of the just revised first quarter growth rate of 2.7%.” That ratio, coupled with the fact that the recent GDP reduction was based primarily on downward revisions to personal consumption and net exports, is troubling.

The recent inventory replenishment cycle has been just what the doctor ordered for the transportation and logistics industry, as business levels bounced off of the Great Recession lows, and transportation rates began to find some support. But at some point, businesses will have replenished their inventories from the depleted levels of the Great Recession, and will be looking for signs that the consumer is buying before continuing the cycle. The numbers behind the recent GDP revision suggest they aren’t going to find it.