Oops, Inventory Correction

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First it was rumors, now it has been announced: JDS Uniphase Corp, an optical network equipment supplier, announced it during its earnings call. Hidden in its explanation of why its outlook was so lousy were the two harmless sounding words: inventory correction.

JDSU’s customers were overstocked and reacted by shutting off their order pipelines. JDSU is one of the dotcomers that crashed and burned and wiped out shareholders and wrote off $56 billion, though it’s still hanging on after a huge reverse stock split that brought its penny stock back into double-digit terrain, at least temporarily. So maybe it isn’t a credible indicator of the health of other American businesses.

But after more than a year and a half of consistent and strong inventory buildup from recession lows, inventories are relatively high at all levels of the economy. Just when the sales outlook becomes murkier. Having run a business where the physical inventory played a huge role, I know what your gut tells you: shut off the order pipeline. At least until you get better visibility. The last thing you want is getting caught in a sales slowdown with high inventories. It’ll eat your lunch.

And if sales actually drift down a bit, it gets ugly. That gut reaction will sweep across the economy and worm itself up through the supply chains, resulting in an inventory depression where everyone furiously shuts off every order pipeline they can get their hands on. And this, in a healthy economy, causes a run-of-the-mill business cycle recession.

Even without inventory depression, US economic growth, at best, will be weak in the second half of 2011, given the other headwinds at the moment, and the uncertainties elsewhere. Add an inventory depression to the mix, and you’re guaranteed a recession.

An inventory depression has an evil twin, the advertising depression, though it seems counter-intuitive: If you need to get rid of your inventory, you’d advertise more, right? Well, if your sales slow down, you suddenly remember the old saw, “You can’t turn a down-market with ads,” and you hunker down and cut your expenses where you can. Laying off people is complicated, and savings, if any, accrue only over time, but advertising budgets are big targets that are easy to gut, and savings are instant. As a consequence, advertising revenues at media companies can drop 30% or more within a couple of quarters. So watch out if you own Google stock or if you think Groupon is the best thing since sliced bread.

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