The bullwhip effect, redux | Financial Times 

Good Morning. A nice little micro-rise in stocks yesterday, as good results from Dollar Tree, Dollar General and Macy’s have suggested that not every retailer is about to fall into the traps that Walmart and Target have made. But there may be more traps elsewhere, as I will discuss below. Email us your thoughts: [email protected] and [email protected]

And if you’re in the US, enjoy the first long weekend of the summer.

The stock is cracking that whip

Already in December I I have written On the bullshit effect. It works like this: In response to a drop in supply or an increase in demand, supply chain companies order over-orders or stockpiles to protect themselves. Permit ordering increases as it moves up the chain from retailer to wholesaler to manufacturer to supplier. The whip cracks when suddenly the demand weakens and there is too much stock in the chain, leading to abundance. I have written:

The question is whether the effects of the bullshit could develop next year [2022], Which leads to excess supply at exactly the same time as the excessive end demand for goods cools down anyway because (please, please) Cubid subsides. This can lead to lack of supply or even deflation. I would not want to attach a probability to it, but it seems possible but unlikely

Ordinary readers of Unhedged will now thinking On Target and Walmart. The stocks of the two major retailers have weakened recently after ordering a lot of the wrong things and reaching billions in extra inventory that they had to mark, at a price of profits. It does sound pretty bullshit.

Albert Edwards of Société Générale thinks the situation of Target and Walmart could be part of a global Bullwhip phenomenon. In a recent letter to investors (in which he kindly mentioned Unhedged) he argued that “an unexpected accumulation of excess inventory, especially during the Fed’s tightening cycle, could help provoke a recession.” He notes that in the fourth and first quarters, U.S. business inventory increased by $ 212 billion and $ 185 billion, respectively, or about one percent of GDP each quarter.

If we have built up too much inventory, then it will be necessary to reduce it, which will result not only in the possibility of price deflation (as in the case of Walmart / Target) but of fewer orders to suppliers and manufacturers. Who will it hurt the most? Probably China:

If we get an inventory problem at the U.S. retail level, manufacturers will clearly see a shortening of orders. It will be China that will be forced (re) to open its liquidity gates first.

But is there a problem with excess inventory? The overall ratio of inventory to sales does not seem particularly high. But, Edwards argues, if you look at certain sectors, the story is not so pretty. Here is his chart:

The chart does not look bad to me – it seems to show inventory ratios for sales just slightly above pre-plague levels. But the growth was enough to make me think. Where other than the balance sheets of large retailers might be hiding excessive inventory? So I researched the companies in the S&P 500.

Admittedly, again, there is no clear pattern that divides industries, but in a number of large companies inventory is rising incredibly fast. A few examples. Stanley Black & Decker is a large company that manufactures hand tools, which were in great demand among bored people during the plague. This is what the inventory ratio for its sales over the last five years looks like:

Intel is a large company that makes computer chips, which were not enough during the epidemic. The following is the inventory ratio for sales over five years:

These two companies stood out to me because they are big and important, in different sectors, and suddenly they have a large inventory. But they are not alone. Within the S&P 500, similar patterns were seen not only at Target and Walmart but also at companies like Garmin, Cisco, Monster Beverage, Ross Stores and others.

I’m not jumping to any conclusions here. It is possible that the increase in inventory in these companies reflects tactical choices in response to epidemic conditions, and can be managed smoothly. What do the companies say? Here’s Stanley’s CFO, Donald Allen, in a conversation in the company’s first quarter:

Remember, last year, we made significant investments in inventory to help meet the excessive demand in the tool business. Our cash flow guidance for 2022 assumes that we can modestly reduce inventory compared to 2021 levels, and we expect much of this improvement to occur in the second half of the year …

Our inventory at the end of the first quarter increased by about $ 850 million compared to the balance at the end of the year ’21. The increase in inventories in our first quarter was mainly due to seasonality of working capital to support the peak of the outdoor buying season, spring sales and the sales day of Father’s Day.

It all sounds logical, if demand comes as expected. Here is Intel CEO Patrick F. Glasinger responding to a question about high inventory levels:

We are building 10 nm [chip] Stock. We have new products that we are entering the market. And we see that some of these will be reversals when we enter the last part of the year, as this inventory will start to flow in the product area. So we would say that this is a very typical management of new product ramps …

As we noted, we saw our customers’ inventory burn in the first quarter. We expect some of this to be in the second quarter as well. But by the second half, we are expecting these adjustments and clearly for the strength of the forecast of the second half, we expect a lot of this inventory burning to end in the first half and a strong second half as we increase our new products.

Again, there is nothing illogical about this. It’s hard to see from the outside who, if anyone, is going to get into the Target-style mess. But it is clear that there is a large stock in large companies at the moment. I do not know if Edwards is right and that may contribute to a global recession. But it is clear that this is something that is important to keep an eye on.

One good read

Global economy Whistle stop tour With Matt Klein and Cardiff Garcia.