Business inventories and sales data helps predict economic activity
Business inventories are important drivers of the economy, especially when they build. Historically, recessions start with a buildup of inventory, which causes businesses to slow production and lay off workers. In fact, most recessions up until the Great Recession followed the same pattern: economic activity increases, which causes inflation. The Fed raises interest rates in response to increased inflation, business activity slows, inventory builds up, and workers get laid off. Once the inventory is worked down, the workers are re-hired and another expansion begins.
While the Great Recession was caused by an excess of debt, business inventories are still important to watch. It is important to focus on the inventory/sales ratio, as spikes in this ratio portend slowdowns. Normalcy is defined as a ratio of around 1.25-1.35x. In early 2009, the ratio spiked to 1.48. Inventory buildups can cause temporary slowdowns in the context of an expanding economy, so it pays to watch them.
Inventories and sales rise in February
Inventories were basically flat between February and March and came in at $1.641 trillion. Sales increased from $1.27T to $1.29T from January, an increase of 1.2%. The inventory to sales ratio decreased to 1.29 from 1.28. Autos and automobile-related businesses increased inventory. Building materials increased in anticipation of the summer construction season. Apparel retailers had flat inventories with increasing sales.
Implications for home builders
Home builders are highly sensitive to the economy. Any sort of slowdown can leave them with excess inventory, and if home prices do not rise, they are stuck with depreciating inventory that costs them to maintain and finance. They will look at the recent business inventory numbers as indicating the economy is continuing to recover. Until we see inventory/sales ratios spike, they will see nothing in the inventory data to suggest caution. Certainly nothing to suggest that mass layoffs are on the horizon.
Home builders have experienced quite the renaissance over the past year as the home builder ETF (XHB) has risen around 48%. Rising real estate prices seem to be driving increases in orders. As the economy improves, renters will begin to become more comfortable with the idea of home ownership. Given the cost of renting is way higher than the cost of owning, marginal increases in the overall state of the economy and confidence will drive home demand. Housing starts have been highly depressed since the real estate collapse and even a small improvement in the economy will drive activity higher. Specific home builder stocks that will be positively affected by changes in consumer sentiment include KB Home (KBH), Lennar (LEN), NVR Homes (NVR), and Toll Brothers (TOL).
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