Key to Recovery: Restocking All Those Shelves - BusinessWeek

Key to Recovery: Restocking All Those Shelves - BusinessWeek

With employment weak and credit tight, worries persist about the possibility of a double-dip recession. But inventory rebuilding should help keep the economy strengthening

By Rich Miller and Anthony Feld

What indicator is former Federal Reserve Chairman Alan Greenspan following most closely these days? No, it's not consumption, business investment, or even the jobs market. It's inventories. "That's a peculiar thing to say," the 84-year-old economist admitted in a Bloomberg Television interview on Mar. 26. But "inventories are critical now."

Companies slashed stockpiles by a record amount last year as demand for their products nosedived. That aggressive de-stocking aggravated the downturn and helped make the decline the deepest since the 1930s. In fact, corporate shedding of inventories accounted for almost a third of the 2.4% contraction in the American economy last year.

Now, with the economy showing signs of recovering and sales picking up, the reverse dynamic is about to set in. Companies from luxury retailer Tiffany (TIF) to Home Depot (HD) are starting to restock their shelves. That should give a fillip to U.S. growth and help keep the recovery on track throughout the year.

The shift is already affecting the economy's bottom line. More than two-thirds of the 5.6% annualized growth of gross domestic product in the fourth quarter of last year came from inventories, the biggest kick from that source since 1987.

And there's more to come. David Hensley, an economist at JPMorgan Chase (JPM) in New York, says inventories will boost gross domestic product in the first three quarters of this year as well, though not to the same degree as in the final three months of 2009. Manufacturing companies added to stockpiles in March for the first time in almost four years, according to a survey of purchasing managers by the Institute for Supply Management. Ten of 13 industries, including clothing makers and computer producers, reported higher inventories.

Companies are restocking because they're finding themselves short of product as sales strengthen. The ratio of business inventories to sales was 1.27 in February, just above a 29-year low of 1.24 set in 2006 and down from a recession high of 1.46 in January 2009. The ratio averaged 1.3 in the last economic expansion, from 2001 to 2007.

Businesses are also adding to their supplies because it's taking longer to get the materials they need to run their plants. Manufacturers reported that deliveries from suppliers slowed in March, according to an index compiled by ISM. The index rose to a more than five-year high of 64.9 last month from 61.1 in February. The higher the index, the more widespread is the slowdown in deliveries.

The turn of the inventory cycle isn't just occurring in the U.S. Companies in Europe and Asia also have been surprised by the recent strength of their sales, according to Hensley, and are starting to add to their stockpiles.

Such restocking will not only boost GDP in the U.S. and elsewhere but also spur hiring as manufacturers ramp up production to meet increased demand. Manufacturing payrolls in the U.S. rose in March for the third consecutive month, something that hasn't happened since 2006.

The danger, of course, is that sales won't increase as much as companies expect, leaving them with more workers and inventory than they need and raising the risk of a relapse in the economy later this year. That's one reason the committee at the National Bureau of Economic Research responsible for determining when recessions begin and end cautions that it's premature to declare an end to the current slump.

Indeed, Martin Feldstein, a Harvard University professor and NBER committee member, still sees a "significant risk" of a double-dip recession. "The consumer is going to have a very hard time," he said. "Unemployment remains an enormous problem."

Greenspan is not nearly so pessimistic. He says the odds that the U.S. will tumble back into recession "have fallen very significantly in the last two months" and forecasts a "self-reinforcing" cycle of industry replenishment that will carry the economy forward. For now, that seems the better bet.