• 2024-10-18

Inventory Cycle Updates

The world of inventory management is constantly shifting, and this year has been no different. By examining the recent trends in China's inventory dynamics, we can uncover the undercurrents affecting the economy. A notable phenomenon is the accelerated decline in inventory growth rates observed over the past six months, raising questions about the underlying causes of this fluctuation.

The core reason for the rapid drop in inventory levels can be traced back to the weak performance of domestic demand earlier in the year. The downward trend in the Producer Price Index (PPI), while significant, is merely a symptom rather than the root cause of this inventory reduction. To truly understand the dynamics at play, we must delve deeper into how profit levels influence inventory management across various sectors. The interplay between corporate profits and inventory levels is quite pronounced, typically reflecting a lagging relationship of around two to three quarters. In other words, it is the profits generated by businesses that often dictate their inventory behavior. As China’s profit margins began to show signs of recovery in June 2023, it typically would be expected that inventory levels would follow suit within the following quarters.

However, the recovery observed since August has been gradual, indicating that the urge to replenish stocks could significantly diminish in the months to come. Companies tend to respond to profit improvements by ramping up production and subsequently increasing their inventory levels, yet this reaction is often dampened by fluctuations in market demand and pricing. Recent price declines have profoundly impacted nominal inventory growth, a situation exacerbated by a clear deceleration in actual inventory levels that cannot simply be attributed to pricing factors.

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Examining the specifics further, one can ascertain that the nominal inventory growth rate saw a decline after an impressive recovery stretch lasting eight months. From July to October 2024, it dropped by 1.3 percentage points, a notable change that was largely influenced by a PPI decrease of 2.1 percentage points during the same period. Even when accounting solely for actual growth, which had remained stable at around 6.5% year-on-year, the lack of robust profit recovery has reduced the momentum for inventory increases.

Further analysis reveals formidable pressures exerted on inventory levels stemming from weak domestic consumption demand. The reliance on domestic sales has consistently lagged behind exports, with sectors dependent on this demand witnessing substantial declines in revenue and profits compared to their export-oriented counterparts. This demand-side weakness has initiated further inventory depletion processes, particularly in domestic-focused industries where inventory-to-sales ratios have surged to unprecedented highs.

When assessing the state of various sectors in the supply chain, a clear disparity emerges. While the upstream industries like manufacturing and resources have been encouraged to replenish stocks due to invigorated policies aimed at maintaining growth, consumer-driven sectors continue to experience stagnant inventory levels as they grapple with diminished demand. The processing and smelting industries, alongside equipment manufacturing, have reported consistent stock replenishment activity post-mid-2023. In October, these segments notched impressive recoveries—a 5.1 and 1.1 percentage points rise from their last year's lows, respectively.

Conversely, sectors focused on consumer goods, such as disposable products and household items, have displayed striking inventory reductions with a recent decline reported in their growth rates. Such differing trends point to an ongoing struggle for consumer manufacturing industries, where inventory growth has slumped not only compared to industrial peers but also in absolute terms.

As the first half of 2024 progresses, these trends are expected to continue. It is evident that while investments in structural construction and heavy equipment are likely to witness a rebound due to favorable policy shifts, consumer demands still linger at disappointing levels. In fact, between September 2023 and June 2024, the growth in consumer demand fell short of that seen in fixed asset investments, with disparities stretching to as far as five percentage points at times. Seasonal patterns suggested that by April 2024, inventory growth rates within consumer goods sectors had plummetted, reaching all-time lows by June.

Moreover, the recent drops in commodity prices significantly hampered profitability across the processing and smelting industries, leading to inventories experiencing pronounced declines. Through October, these industries witnessed a PPI drop of 3.6 percentage points compared to July levels—a decline exceeding that of equipment and consumer manufacturing sectors. This contrast underlines the challenges faced by businesses that rely on stable pricing to build robust inventories.

Looking forward, the pressing question remains: which sectors hold the highest probability for recovery in inventory levels? The notion of “export grabbing” offers a glimpse of hope, as international demand is expected to bolster the profitability of export-dependent industries. Indicators such as new export orders point to a resurgence, potentially leading to inventory restocking trends extending into mid-2024.

Furthermore, government “two new” policies aimed at drawing consumer spending back into the economy may catalyze a more upward trajectory for inventory levels, particularly in connection with sectors benefiting from technology upgrades and infrastructure spending. As we advance into 2024, we expect to see pronounced improvement in the consumer sectors, as well as in those industries aligning their strategies to leverage favorable policies surrounding electric appliances and automotive sales. Given the current status of historical inventory-to-sales ratios and corresponding profit margins, the potential for recovery remains alive.

However, it is worthwhile to note that economic transformations are often impeded by short-term constraints. The reality of fewer incentives for consumer goods stems from weak domestic consumption patterns and broader economic policy impacts that remain tepid. The evolving landscape within the housing market presents another unpredictable variable with far-reaching implications on consumer spending and the overall economic climate.

In summary, as we wade through the intricate waters of inventory dynamics, the path forward is not straightforward. As companies redefine approaches and strategies against a backdrop of fluctuating demand and pricing, the ultimate recovery of inventory levels will hinge on multiple evolving factors, not least of which are consumer confidence and global market conditions.

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