Edwards On Inventory Recovery & Consumer Fundamentals

Albert Edwards, the top ranked strategist at Societe Generale, has a non-consensus view on inventory liquidation ... he calls it "Some dark deflationary thoughts in the face of market euphoria". I leave the part of market euphoria, but focus on inventory recovery hope.

Albert argues:

We continually hear that the Lehman's debacle produced an excessive liquidation of inventory as companies over-reacted to events and that if production schedules are stepped up to prevent additional declines in stocks, this will make substantial additions to GDP growth (e.g. a 4½% addition if Q3 inventory change comes in at zero).

This is simply wrong. The inventory liquidation, although large in $bn terms, has NOT been excessive given the unprecedented 18% collapse in sales (see right-hand chart below). The rate of inventory decline, at 8% yoy, has barely exceeded that seen at the nadir of the last shallow recession in 2001/2 when sales fell only around 5% yoy. Manufacturing and wholesale inventory/sales ratios are still excessive (see left-hand chart below). This is exactly the explanation the American Trucking Association Chief Economist Bob Costello gave on the release of the 2½% decline in June's tonnage - link. That is why recent inventory data has been surprising on the downside and why H2 growth will be weaker than expected.

The excess inventory situation would not be such an issue if final demand revived. Yet as consumption continues to flat-line, recent data revisions in the latest GDP release show the true extent of shockingly bad consumer fundamentals (see charts below).

US nominal household incomes are now contracting at an unprecedented rate. The largest component of household income is wages and salaries which had been declining some 1% yoy. But after revisions the statisticians now admit to an unprecedented 4.8% decline! Total pre-tax household income is now recorded as falling 3.4% yoy in June.

"But aren't tax cuts holding up household incomes?" I hear you say. Even factoring in massive tax cuts, disposable income is still down 1.3% yoy. Total hours worked in the private sector are down a horrendous 7% yoy. This headlong plunge into negative NOMINAL income and GDP numbers is exactly what happened in Japan and is the stuff of classic Fisher debt deflation ... As debt/income ratios are excessive and need to be de-leveraged, a declining denominator will be the key driver to the coming "Vortex of Debility".

However, John Hempton is extrapolating his view on Brunswick to the whole economy ...

Who is right?