When the economy is in trouble there’s some good news-bad news in falling inventories.
The bad news is some of the inventory loss reflects businesses closings and retailers holding fire sales in attempt to lure customers into the store.
What the retailers may not be doing is re-ordering and that causes inventories to fall at the wholesale and manufacturing levels.
When wholesalers aren’t getting orders from customers they aren’t placing orders with manufacturers for more products.
In a bad economy, it is not just the retail segment that isn’t re-ordering, but the business-to-business market also contracts.
The bottom-line is jobs are shed at all levels and deflation (constant downward pressure on prices) becomes an issue.
So, where’s the good news?
Although it may not feel like it at the time (especially if you are one of the thousands losing your job), clearing out inventory sets the stage for the eventual rebound.
When the economy does turn around, pent up demand from consumers will drive prices up because inventories are low (low supply and high demand equal higher prices).
As business increases, all level of the production and distribution process kick in gear to satisfy demand.
This can mean businesses recall laid off workers and begin hiring new workers. That is the way it should work.
If the economy doesn’t return with some gusto, jobs may not return as fast and companies may not grow as fast.
There is no way of knowing what is going to happen. History suggest that recessions and bear markets set the stage for future booms, but that is not guaranteed.
Lower inventory levels do mean that when the economy begins to rebound, companies that are prepared to ramp up production are in the best position to benefit.
Which companies will come out of an economic downturn or recession in the best position to benefit by rebuilding inventories?
Low debt and high cash are two key indicators. Stocks in these companies have good potential for major gains.
