November 12, 2007 / 6:22 PM / 12 years ago

Recession fears grow as inventories swell

WASHINGTON (Reuters) - Unsold goods are piling up in warehouses as the housing meltdown and soaring oil prices strain consumers, raising fears that already glum fourth-quarter growth prospects may tip toward recession.

A worker checks a shipment of outgoing boxes at the warehouse facility in New Castle, Delaware, in this November 24, 2006 file photo. Unsold goods are piling up in warehouses as the housing meltdown and soaring oil prices strain consumers, raising fears that already glum fourth-quarter growth prospects may tip toward recession. REUTERS/Tim Shaffer

Federal Reserve Chairman Ben Bernanke warned last week that economic growth would slow from the third quarter’s surprisingly strong 3.9 percent annual rate. But recent data on inventories suggests the slowdown may be even more severe than the central bank has anticipated.

Wholesale inventories rose 0.8 percent in September, far greater than the 0.2 percent gain that analysts had expected, according to government data released last week. That will likely boost third-quarter growth even more, but take a toll on the current period as businesses work off the unsold goods.

The Institute for Supply Management’s closely watched report on manufacturers told a similar story for October. ISM’s survey, released earlier this month, showed that manufacturers were increasingly worried about customers’ inventory levels, with stockpiles growing in a wide range of sectors, from plastics and rubber products to food and tobacco.

“The main source of concern at this point is how this inventory build will unwind in the fourth quarter,” Merrill Lynch analyst David Rosenberg wrote in a note to clients.

Rosenberg estimated that revised third-quarter GDP data will show an extra $18 billion in inventory. An equal amount may be erased from the fourth quarter, which would take his GDP forecast “perilously close to flat, or even negative.”

Ordinarily, an inventory build-up is seen as a temporary imbalance that the world’s biggest economy can quickly digest. But with consumer confidence sliding and recession fears mounting, this inventory spike raises questions about demand.

Determining how the current episode will play out is tricky because economists have few tools to gauge how tightening credit will ultimately affect spending, said Douglas Lee, chief economist for research group Economics from Washington.

Until recently, Lee had been expecting the economy to grow at a 1.5 percent pace in the fourth quarter. Now, he thinks it will come to a standstill, in part due to swelling inventories, and he looks for only modest improvement in the first quarter.

“A negative growth rate in the fourth quarter is quite possible,” he said. While one quarter of contraction may not meet the recession criteria, “recession risk is rising and recession talk will fill the news.”

Lee said some of the third-quarter inventory increase was tied to auto manufacturers bracing for possible labor strikes, and those cars will likely be sold off in the coming months.

But inventories also rose in many other categories, suggesting that consumption was weaker than expected. That may be tougher to overcome as consumers grapple with a housing recession, steep energy costs and tightening credit terms.

Strong export sales made up for some of the domestic weakness last quarter, but it is unlikely that the pace will be sustained in the current period, Lee said.


Jan Hatzius, an economist with Goldman Sachs, noted that ISM’s customer inventories index jumped to 54.0 in October from 50.0 a month earlier, putting it at the highest point since January 2001 — two months before the last recession began.

“The fact that there was a very similar spike before the 2001 recession suggests that this index may be a valuable near-horizon indicator of recession because it signals real urgency in scaling back production,” he wrote.

The overall ISM manufacturing index for October slipped to 50.9 from 52.0, consistent with a slow-growing economy.

The sluggishness is apparent in the retail sector, where 70 percent of chain stores posted weaker-than-expected October sales results, according to research firm Retail Metrics.

“We expect the challenging retail environment to continue for the foreseeable future,” Mike Ullman, chairman and chief executive officer of department store chain J.C. Penney (JCP.N), said last week. He added that the company would keep inventory levels tight through 2008.

That was far gloomier than his assessment just a month earlier, when he said he was “encouraged” by customers’ response to fall merchandise, despite the housing woes.

Investors will get a closer look at the health of the retail sector on Wednesday, when the Commerce Department releases its monthly retail sales report. Economists polled by Reuters are expecting a slim 0.2 percent rise for the month, which would be down sharply from September’s 0.6 percent gain.

Ullman is not the only CEO to turn more pessimistic in recent weeks. John Chambers, CEO of technology heavyweight Cisco Systems Inc (CSCO.O), helped spark a stock market rally in August when he said this was the strongest global economy he had seen in his career.

But last week, Chambers reported “dramatic decreases” in orders from U.S. banks and predicted that demand from segments such as banking and retail would remain “lumpy” for a while.

The key question is whether that “lumpy” demand will force a reluctant Fed to step in with more interest rate cuts.

Editing by Dan Grebler

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