Inventory cycles play an important role in accelerating the momentum of economic growth, inflation, and corporate profitability. Companies generally build stock during the expansion phase, when consumption is expected to continue. Conversely, they liquidate stock when they are either caught out by a faster-than-expected slowing in that demand (having resulted in involuntary inventory accumulation) or when they anticipate growth weakness ahead (voluntary liquidation).
After much of 2021 and 2022 was spent ramping up inventories, 2023 was the year of destocking. It seems that current levels are now roughly around desired levels, with some companies increasingly concerned about shortages. The sharp drop in the ISM inventory index into “too low” territory would seem to be consistent with greater concerns about renewed supply chain disruptions related to the problems in the Red Sea and the Panama Canal, as opposed to optimism about accelerating demand.
It is difficult to know to what extent companies are willing and able to follow through on their previously expressed desire to increase supply chain redundancies and carry high levels of inventories. Slightly faster inflation and the elevated threat of further disruptions would be consistent with such sentiment, though advances in technology also suggest such a buildup may not be necessary.