Two of the latest economic releases that caught my eye were
wholesale sales and inventories, partly because sales fell off a
cliff, but also because inventories did the opposite, rising
Sales at wholesalers fell 1.9% in January, the largest drop
since 2009, and a lot of the blame, rightly or wrongly, was placed
on the wintry weather. However, inventories still grew at
0.6% after an upwardly adjusted December gain of 0.4%, painting a
completely different picture.
What do these two conflicting data points show us?
Inventories precede Sales
Inventories typically rise out of optimism as companies increase
them in preparation of more sales. Companies generally buy
inventory from the raw material and goods producers. Sales,
on the other hand, are usually of the final product, the former
inventories of a business that are eventually sold to the consumer
or another business.
Portfolio Really Diversified?
Generally, rising inventories are good, as long as sales keep
However, if sales start falling while inventories continue
rising it increases the risk of future write offs and mark downs as
inventory becomes obsolete and businesses have to sacrifice price
in order to eventually sell product. Such an event can warn
of a change in the consumer's (NYSEARCA:XLY) habits as there is too
much supply and/or too little demand.
That is one reason why January's numbers caught my eye.
Wholesale inventories are significantly outpacing sales.
Autos - a Barometer of Total Inventory/Sales
Rising inventories can warn that corporations are either too
optimistic about the future, or they are too focused on their own
sales numbers that they partake in "channel stuffing" in order to
make their own sales numbers. They pass on their inventory as
sales to other businesses which then take it as inventory.
Eventually, though, the gig comes up as the end consumer is
ultimately needed to convert inventories to sales.
A popular metric used to track the health of inventories as well
as help identify channel stuffing is the inventories to sales
The chart below tracks this through time in the auto industry
and shows why investors should take note of the rising auto
inventory/sales ratio as it likely has implications for auto stocks
such as GM (
), Ford (
), and Honda (
In the chart below the automobile inventory to sales ratio
generally stays between 2.0 and 2.7x. When the ratio gets
outside these levels, as it has been now for two months, it should
raise red flags to investors. When it is below 2.0x it often
precedes an economic and equity market upturn, but when it is above
2.7x it often precedes sales slowdowns in autos.
Auto sales have been growing steadily per year since the 2009
recession bottom, finally in late 2012 surpassing the 15 million
car level that has been associated with most other prior positive
But, the inventory to sales ratio now sits at 2.9x, one of the
highest levels ever, and the chart displays why this should be
viewed as a warning to investors. This ratio has only been
this high two times in the past, once in 1995 and again in 2008 at
the height of the last recession.
In December 1994, unit car sales peaked out at a six month
average of 15.1 million units, one month before this inventory to
sales ratio previously reached 2.8x. It took until 1998
before average six month sales started to climb meaningfully above
that level again. Car sales were essentially flat for four
years once the ratio surpassed 2.8x in 1994.
By the time the ratio hit 2.8x in 2008, the markets and auto
sales were already in freefall, but it is clear that inventory was
very overestimated in that instance as well.
If history is to be our guide then we could draw the conclusion
that today either optimism of future sales is too high or the auto
makers have been caught channel stuffing, either way, we should
expect auto sales to slow in the coming months/years as inventory
comes back in line with historical averages.
Here's the good news: You should be able to get a great deal on
a vehicle (
) today as dealers (
) have more inventory than ever. And as long as this inventory to
sales ratio keeps rising, these deals should only get better.
Profit Strategy Newsletter
keeps investors on the right side of the trends by using
fundamental, technical, and sentiment analysis. Auto sales
are likely to slow down as the market is oversaturated with
inventory and risks a pullback from the optimism that sits near
Follow us on Twitter @