Oh No, The Inventory Correction Is Confirmed

Orders are plummeting, the dreaded inventory correction is here. In our already miserable economy, this is going to be a rough ride.

After an inventory-buildup frenzy that lasted a year and a half, inventories are relatively high throughout the economy, just when sales are starting to wobble—a scary crossing of facts. I still remember the knot in my gut back in the day when I was running a business whose inventories were a significant portion of its assets. And the first thing your gut tells you is to choke off the order pipeline. Because getting caught in a sales downturn with high inventories can be anywhere from costly to deadly.

And now, executives across the country are feeling the same knot in their collective gut, and they’re reacting. This is being documented by economic data. The Business Outlook Survey by the Philadelphia Fed showed new orders crashing 27 points. The New York Fed’s August Manufacturing Survey had them drop to a negative -7.8. In the Chicago Fed’s National Activity Index, orders were also negative.

While the August durable goods report had a positive headline number, many of the business components looked outright scary: Machinery –1.5%, Computers –7.4%, Communications equipment –24.8%, and Electrical equipment –1.8%.

Corporate announcements are confirming the trend every day. At first, it was JDS Uniphase that said that its customers were cutting their orders due to an inventory correction on their part. Now other companies are confirming the trend.

Applied Materials came out last night with an updated forecast, a stunner of ugliness: sales this quarter will collapse by up to 30%! And its orders to its own suppliers must look similarly nauseating.

Acer’s inventory problems are such that it has decided to just write off  $150 million. And surely, it is choking off its own order pipeline.

Freescale Semiconductors announced yesterday morning that its clients are ordering less because their own orders have been hit.

As each level in the economy cuts back on orders, it creates a wave of sales declines that blows back through the supply chain. With a multiplier effect. To cope, companies will adjust their workforce. So, there will be layoffs. Advertising will take a kick in the groin simply because it’s a big expense that is easy to cull. Other expenses are also on the chopping block, further reducing sales for suppliers. The irony in any economy: one company’s expense is another company’s revenue, and when expenses get cut, it reverberates through the economy as declining revenues, causing further expense reductions, layoffs, etc.

And no, there is nothing the Fed can do or that Ben Bernanke can announce in Jackson Hole that will reverse that trend. High inventories have to be worked down. On the other hand, if the Fed decides to print more money and hand it over to its cronies, it will heat up inflation even more, drive real yields (and incomes) deeper into negative hell, and lower the purchasing power of the American middle class even further. A prescription for disaster.

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