Inventories have never been as much of a factor in GDP growth during expansions over the last 35 years as they have been in the current cycle, but that influence is waning.
Inventories boosted GDP growth by 0.8 percentage points in the most recent quarter, according to a special report by Wells Fargo. “The combination of the most-tepid growth backdrop in the post-WWII era, the unique changes in the energy sector (both technological and price swings) as well as a continued evolution in inventory management have all played a role in elevating the importance of inventories in this cycle,” wrote report authors Tim Quinlan, senior economist, Sara House, economist, and Shannon Seery, economic analyst. But now in its late stage, the expansion will likely be driven by other factors returning to more normal, long-term rates.
Dating back to the 1980s, the contribution of inventories as a share of the overall growth rate—especially in a slow GDP growth environment—is equivalent to 45% of GDP growth; much higher than the 27% to 34% seen in prior expansions, the Wells analysts said.
Looking toward the end of 2018, Wells expects modest inventory building with quarterly jumps from $40 billion to $50 billion. “Our base-case scenario is informed by our prior study of late-cycle inventory dynamics which suggests a slowing in the pace of inventory investment.”
During this cycle, inventory swings in the energy sector have been an important driver. Crude inventories boosted by shale supplies began growing in 2014. By the first quarter of 2015, inventories from energy—as reflected in government data for the mining, utilities and the construction sectors—boosted topline GDP by 1.5 percentage points. Energy sector inventories began to slow and then decline over the past three quarters, while inventories of manufactured and wholesale petroleum products after adjusting for inflation were 7% higher, year-over-year, in the third quarter, compared to the 25% annual gain seen in the final quarter of 2016.
Meanwhile, nonfarm business inventories also jumped to the largest annual gain on record in 2015, driven in part by slowing sales, the Wells analysts said. That inventory-to-sales ratio began to decrease in mid-2016, however, and has since dropped to its lowest level in nearly two years as businesses cut back on inventory investment. Still, elevated inventory levels in some industries, such as metals, machinery, chemicals and energy products, suggest a reduction in the pace of inventory building in the near term.
Retail inventories relative to sales have been at more healthy levels in recent years, hitting a 20-year low in the third quarter, Wells said.
But in the coming year, stronger growth is expected to bring businesses to add to inventories. “The pace is not expected to be as jaw-dropping as earlier in the expansion when businesses got out over their skis then subsequently had to dial back their inventory building. The relative importance of inventories as a growth driver should recede as broader growth picks up, the volatility in the energy sector fades a bit and as businesses appear to be taking a more deliberate approach to stockpiling.”
– Nicholas Stern, managing editor