Historically, Huge Inventory Boosts Like In Q4 Have Ended Very Badly

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Many of us know by now that Q4’s 5.7% GDP blow-out was boosted 3.5% by an inventory adjustment, whereby the rate of businesses’ inventory-cutting slowed.Optimists are reading this as the beginning of a new inventory cycle, whereby slowing inventory reductions will eventually reverse into inventory growth, thus fueling future GDP growth.

Kevin Hassett of the American Enterprise Institute doesn’t fall into in this camp.

According to Mr. Hassett, historically there have been nine quarters since 1970 when GDP growth of over 3% benefited from an inventory change of the magnitude we just witnessed for Q4.

Unfortunately, the economy usually hit a sudden speed bump right after such an event. Thus he believes that GDP growth could easily hit zero per cent (no growth) in the current quarter:

Bloomberg: Inventory spikes make for blowout quarters. In the nine quarters with such spikes, the average growth rate was 6.6 per cent and the average inventory contribution was 4.4 per cent, even higher than what was observed for last quarter.

Spikes also produce hangovers. The average growth rate in the quarter after a spike was 0.9 per cent, a whopping 5.7 per cent lower. In the second quarter following a spike, the average growth rate is just 1.6 per cent. 

To be sure, the inventory story is not the only red flag right now. The unemployment rate in the U.S. is hovering around 10 per cent and has shown little sign of recovery.

We might consider ourselves lucky if we experience only the typical decline in growth that follows an inventory spike. In that case, first-quarter growth in 2010 will be right around zero. If that happens, talk of a double-dip recession will ignite.

Just keep in mind that the central argument here revolves around whether or not Q4’s slowing of inventory cuts precedes a new cycle of inventory growth. Inventory adjustment boosts to GDP aren’t necessarily something to be discredited every time. It all depends on how the inventory cycle plays out. Read more here >

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