Stocks Rapidly Pricing In Growth/Profit Tailwind From Inventory Cycle, Among Others

After the sharp contraction in economic activity in the early months this year, inventories are running low. Growth gets a tailwind as they get rebuilt. There is tight correlation between economic growth and corporate profits. Stocks are anticipating this.

Home sales are on fire. In May, sales of existing homes were down to a seasonally adjusted annual rate of 3.91 million units; in October, they stood at 6.85 million. Similarly, new home sales dropped as low as 570,000 units in April; in both August and September, they were north of a million, with October at 999,000. These are multi-year highs.

Inventory is tight. In October, the supply of existing and new homes was 2.5 and 3.5 months, in that order (Chart 1). Of course, this is based on the current sales pace, meaning if sales weaken, more homes will be available, but the fact remains that the inventory of homes for sale is dwindling, which is helping push up the price.

The phenomenon is not just limited to housing.

In manufacturing and trade, the inventories-to-sales ratio dropped to a six-year low 1.32 in August, with a flat September. Earlier, the ratio shot up to a record 1.67 in April (Chart 2).

A lot of the improvement in the ratio is due to sales that recovered quickly. In April, sales came in at $1.18 trillion (seasonally adjusted); by September, they had risen to $1.47 trillion. Inventories, on the other hand, went from $1.98 trillion to $1.93 trillion between the periods. In all of last year, inventories were just north of $2 trillion before coming under pressure early this year. They have been slightly rising since hitting $1.91 trillion in June.

The slight buildup in inventories in recent months after depletion earlier is also evident elsewhere.

In manufacturing, the ISM inventories sub-index dropped to 44.4 in August, which was the lowest since January 2014. October’s was up 4.8 points month-over-month to 51.9 – an 18-month high. Orders similarly jumped 7.7 points m/m to 67.9 in that month, which has the highest since January 2004.

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