Heavy Inventories Have The Economy Breathing Harder

The frigid weather that made an early appearance across much of the U.S. has raised fears that this winter could be especially brutal. Early 1996 also could see a chill in the economy--one brought by a prolonged inventory adjustment, not plummeting temperatures.

As more data filter in, it is becoming clear that the October slowdown was no fluke. The fourth quarter is shaping up to be more sluggish than the third quarter's gallop. The mix of the data also suggests that the weakness is likely to carry over into the first quarter.

Hiring is slowing--and factory payrolls are shrinking outright. Businesses are dealing with higher inventory levels than they probably want, and housing demand is running out of steam. At the same time, consumer buying, though rising, doesn't exhibit the vitality that warms retailers' hearts. One reason: Consumers are carrying a record amount of installment credit.

The imbalances evident in the economy are not significant enough to reverse the expansion. As long as a credible budget deal is worked out in Washington, a recession is not in the cards for 1996. However, growth in the current quarter and the next will not be very strong. In particular, demand isn't rising very quickly, so output growth will ease back until inventories are more manageable.

SHOPPERS PICKED UP THE PACE a bit in November, but the contribution of consumer spending to fourth-quarter economic growth still looks only modest.

Retail sales rose a solid 0.8% in November, led by furniture, building materials, and a rebound in apparel. However, the gain followed declines in both September and October, and the Johnson Redbook survey of retailers through Dec. 9 showed weak December sales. Even if December buying rises 0.5%, fourth-quarter sales will increase at an annual rate of only 1.7% (chart). That would result in the weakest fourth quarter for retail sales in four years.

Because of steep discounting, however, real retail sales--and thus overall consumer spending--for the quarter will look somewhat healthier. Retailers' profits may suffer, though. In November, the dollar value of sales was up only 3.2% from a year ago, a weak showing for this crucial time of year for retailers.

Shoppers' restraint can be traced to two fundamental factors for consumer spending. One, job growth has slowed in the second half. And two, some households are running into credit problems.

Nonfarm payrolls increased by 166,000 in November, but the Labor Dept. cautioned that the top-line number was distorted. An extra week between survey periods and new seasonal factors added 69,000 jobs. Unemployment edged up to 5.6% from 5.5%.

Job growth so far in the second half has slowed to a monthly average of 123,000, down from a 154,000 pace in the first six months. As usual, the weakest job market is at the factory (chart). Jobs there fell by 32,000 in November, the seventh loss in the past eight months.

Hours worked in manufacturing, however, held steady at 41.5 hours, with a hefty 4.4 hours in overtime. The long workweek suggests that gains in industrial production are coming from increasing productivity, not from adding more workers.

Not all the labor-market news is downbeat. Service payrolls continue to expand, with 197,000 jobs added in November. The 74,000 gain in retail trade was exaggerated by the seasonal-adjustment process, but even excluding store jobs, service payrolls rose a healthy 123,000.

As a result, income growth remains sufficient to support a moderate pace of consumer buying. Wages for nonfarm production workers fell one cent in November, to $11.58 an hour. But compared with year-ago levels, wages are rising by 2.9% so far in the fourth quarter. That's just a hair's breadth above the inflation rate. The growth in hourly pay has been above the inflation rate for three quarters.

THE PROBLEM for some households, though, is that debt is creeping into the danger zone--and some borrowers are falling behind in their payments.

Installment debt jumped by $10.6 billion in October, up sharply from the $4.1 billion gain in September. Assuming a 0.5% increase in disposable income for October--the actual data will not be released until Dec. 21--then consumer debt outstanding, now more than $1 trillion, would equal 18.9% of disposable income. That's a record high--surpassing the debt levels of even the credit-crazed 1980s. And this rise has occurred even before the holiday rush to "charge it."

Not surprisingly, the Mortgage Bankers Assn. reports that 4.24% of mortgages were overdue in the third quarter. That's the second quarterly rise since the delinquency rate hit a 22-year low of 3.91% in the first quarter. In addition, Bankcard Barometer reports that credit-card delinquency rates have been rising throughout 1995, hitting 4.38% by the end of November, a 2 1/2-year high.

Slower job growth and credit problems also are contributing to the slowdown in home buying. New single-family home sales fell 2.7% in October, to an annual rate of 673,000. It was the third straight decline, pushing the months' supply of unsold homes up to 6.5 from 5.5 in July.

Looking ahead, consumers are likely to concentrate on paying down existing IOUs in the first quarter. That's one reason why household demand will continue to rise at a mediocre pace into early 1996.

AN OUTRIGHT RETRENCHMENT by shoppers is unlikely, but soft consumer demand suggests that the current inventory adjustment may extend into 1996. Manufacturing inventories rose by 0.4% in October, even though factory shipments fell 0.4%. On a yearly basis, inventories have been growing faster than sales for four months now (chart).

Wholesalers also are dealing with excess stock levels. Their inventories increased by 0.7% in October, while sales were down 0.4%. A buildup of extra goods in the distribution pipeline is sure to double back and hit factories in the form of fewer orders. That means slower growth in output later on.

The inventory realignment also means that the November flareup in producer price inflation will sputter out quickly. Producer prices of finished goods jumped 0.5% for all items last month, and by 0.4% when food and energy are excluded.

Higher prices for 1996 models of new cars and trucks accounted for most of the runup. But given the so-so demand for motor vehicles, those markups could soon be wiped out by rebates and incentive packages. Even with the November gain, producer prices are up only 2% from a year ago.

For now, the inventory imbalance does not appear immense enough to cause severe cutbacks in production, but the latest numbers draw sufficient attention to the problem that future data bear watching. Still, as long as demand keeps rising, any chill in the economy should thaw out before the spring.

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