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When Asia Sneezes...

March 15, 2007
All eyes were on Asia at the end of February as stocks took a dive, setting off a ripple effect that spread around the world. Was it a correction or a

All eyes were on Asia at the end of February as stocks took a dive, setting off a ripple effect that spread around the world. Was it a correction or a sign of collapse? While politicos and prognosticators sought to calm market jitters, it's the fundamentals that tell the story. They only had to ask a logistics professional.

While the search continues for the smoking gun—or at least the trigger— that set off the economic chain reaction, some of the evidence of slower growth was in plain sight. Wall Street analysts were ahead of the U.S. Department of Commerce (www.commerce.gov) in expecting slower growth as businesses took steps to avoid building inventory. A Commerce Department report revised the 2006 fourth quarter growth estimate for the gross domestic profit (GDP) down from 3.5% to 2.2%, an unusually large correction. In fact, Wall Street analysts had been expecting a number in line with that 2.2% figure. The big culprit in the large-scale revision appears to be inventories.

Rosalyn Wilson, author of the annual State of Logistics Report, agrees that it's logical for companies to stop building inventories when they see demand slowing. But there was some inventory build up initially as the economy was slowing down, and Wilson felt the inventories were beginning to bloat. But, she says, it looks like companies have adjusted.

The long logistics pipeline is an important factor in the inventory position, and everyone is not quite there on how to best calculate what is needed with the longer supply chains, notes Wilson. In addition, she feels that earlier problems with stockouts had companies concerned about not facing empty shelves again, so many companies erred on the side of deeper inventories. With the economy slowing, companies can't afford that kind of position for long, says Wilson.

Adding to the fog surrounding the overall inventory position is the fact that a number of major retailers took a position that they would reduce inventories. What they did was push those inventories off on their suppliers and they made demands on those suppliers to provide rapid replenishment. So, while retailers' inventories may have dropped, overall business inventories did not see a corresponding decline because that inventory was just elsewhere in the pipeline. Echoing her overall remark, Wilson says those suppliers in the retail supply chain that had taken on larger inventories may have been a little slow to respond, but now they don't have a choice, and they have begun to get a handle on their inventories.

If we are clearing inventories out, says Wilson, inventories should be low relative to sales. But, if sales are falling and we're doing a good job of matching that drop, the numbers will fall together.

The latest business inventory/sales ratios from the U.S. Census Bureau (www.census.gov) run through December 2006. Sales were estimated at $1,066 billion in December, up 1.4% from November and up 4.4% from December 2005. Inventories stood at $1,366 billion, unchanged from November but up 6.0% from December 2005.

With sales rising a little faster than inventories from November to December, the overall position has improved. But, when compared with a year ago, inventories have grown relative to sales. Based on the way Wilson describes the overall business performance, the month-to-month improvement could be the beginning of businesses coping with the supply chain challenges and reining in inventories. Still, one month does not make a trend.

One measure for manufacturing does offer a little more of a trend. Steel imports fell by 10% in January, according to the U.S. International Trade Administration (www.trade.gov). This follows a month-to-month decline of 13% in December and a 13% drop in November.

The critical economic numbers many analysts have been watching include construction and new home starts as well as durable goods orders. Each reported a drop in January.

Construction spending for January 2007 was off 0.8% from December 2006. At a seasonally adjusted $1,180 billion, this is 1.2% below January 2006. Sales of new, single-family homes were at a seasonally adjusted annual rate of 937,000 for the month of January, 16.6% below December 2006 and 20.1% lower than January 2006. Building permits for privately owned housing units fell by 2.8% from December 2006 to January 2007 or by 28.6% from the prior January.

U.S. Federal Reserve Chairman Ben Bernanke indicated the drop in new home sales was one of the sharpest declines in 13 years. Much of the impact was focused in materials groups. With home building and home improvement spending expected to remain low during the year, those areas could continue to feel the pinch.

Another headline grabber was the drop in durable goods orders, down 7.8% in January. Durable goods orders were off by $17.1 billion. While new orders were off, shipments rose 0.2% or $500 million in January—continuing a trend over five of the last six months. Unfilled orders have increased in 20 of the last 21 months, according to the U.S. Census Bureau.

With new orders for durable goods dropping, how have inventories for the category fared? January was the 12th month of the last 13 showing an increase in durable goods inventories. The actual January increase was $1 billion or 0.3%. This is on top of a 0.7% increase in December 2006.

Asian suppliers looking at a possible slowdown in the U.S. market were encouraged in any doom-and-gloom thinking by remarks of former Federal Reserve Chairman Alan Greenspan. Greenspan commented that a recession could be possible. The U.S. expansion that started in 2001 was showing signs of ending, he said.

The timing of Greenspan's remarks makes it difficult to separate his statements from factors in Asian markets that could account for the market drop. Mass behavior in a market that is dominated by individual investors is difficult to explain. Some analysts think investors were claiming profits earned in the market's continued rise of recent years. Greenspan's comments came at the end of the Chinese New Year celebration in Mainland China. His negative pronouncements on the U.S. economy, coupled with perceptions that China could be nearing the end of a "speculative bubble," and the symbolism of the time of year could have been a sufficient trigger.

Key figures on the U.S. economy had not been released when Greenspan's comments were made, but they show U.S. manufacturing actually expanding in February and personal income rising at the fastest rate in a year. Balancing this against the expected slowdown analysts had already been discussing, there may have been less call for pessimism about the impact of U.S. consumption on the key Asian economies representing suppliers.

"There's a reasonable possibility that we'll see some strengthening of the economy," said Bernanke, implying it could occur as early as the middle of the year.

In fact, the National Association for Business Economics forecasts 2.5% growth in the U.S. GDP in the first quarter. This would be followed in the April-June timeframe by a 2.6% rise and then by a 2.9% uptick from July through September. Inflation has been "calming" at a 1.9% rate in the fourth quarter of 2006 vs. 2.2% in the prior quarter. Consumer spending in the fourth quarter rose 4.2% vs. 2.8% in the third quarter. Though industrial spending in areas such as equipment, software and new plants and commercial buildings was down, and market shifts related to the slowing housing market were occurring, other areas such as tobacco and household consumer goods were on the rise.

Asian economies are growing, as are European economies. Indonesian officials forecast that their economy could rise 6% to 7% this year, its fastest growth in a decade. Malaysia also reported a strong rise of 5.9% (its average annual growth has been 6% since 2000). In China, the December manufacturing index was down from Novembers' fourmonth high, but it was still indicating growth.

"Latest survey data signaled a further improvement in Chinese manufacturing operating conditions in December—the thirteenth in successive months," according to the CLSA China Purchasing Managers' Index.

The China government was "carefully monitoring the external demand environment and inflation pressures, especially wages, at home," said CLSA Chief Economist Dr. Jim Walker. He noted that new export orders were back on the growth side of the "boom-bust" line but as the U.S. economy was slowing, he expected that aspect of the Purchasing Managers' Index to drop. New export orders rose only modestly, he commented.

While the shock wave that emanated from the Shanghai Exchange continued to send ripples through financial markets for days, the United States and Europe continued to import heavily from Asia. And while some slowing in production or exports may be forecast, the fundamental economic engine continued to chug along. Orders, manufacturing output and freight volumes were adjusting to each other as they had been for weeks, and they showed no signs of serious disruption in the days following the Shanghai events, so it may be that the events had little to do with the day-to-day realities of global supply chains.