Is rising business inventory growth a bull market indicator?

Market Realist

The investment recovery is back, meaning great news for investors (Part 5 of 15)

(Continued from Part 4)

Inventory growth above average—at last

The below graph suggests that the recent recovery in the economy has encouraged producers to grow inventory to meet demand. As the economy firms, businesses that are more confident in stabilizing or growing sales may be more inclined to boost production and carry more inventory. Business inventory growth as a percent of gross domestic product, or GDP, is once again back to pre-crisis levels. This article considers the implications of growing business inventories in the context of an improving investment environment and the outlook for investors.

Will investment sustain business expansion?

The above data on investment growth is based on a two-year average, while the prior graph was based on three-year data. It’s important to note that, while investment growth continues and is still strong by historical standards, the rate of acceleration has declined from around 7.0% to around 5.0% based on this measure. Though the apparent softening of investment growth data may be a bit disconcerting, the fact that fixed investment growth is still at 5.0% while residential fixed investment has accelerated to 10.0% reflects a strong trend in investment growth overall over the past two years. As a result, it would appear that businesses are fairly comfortable with growing inventory on the expectation that, despite modest current growth in consumption, the improvement in investment data should reinforce the current recovery and future consumption capability.

To see how drastically residential investment declined in the crisis and how far it has recovered, please see the next article in this series.

For investors concerned with rising interest rates as a result of the economic recovery, please see Fixed income ETFs: Short-duration alternatives for bonds.

Equity outlook: Constructive

Despite problems in Ukraine and China, and despite the modest consumption data in the USA, U.S. labor markets appear to be well into recovery—with the exception of the long-term unemployed. From this perspective, it would appear that the U.S. is probably the most attractive major investment market at the moment. While the fixed investment environment of the U.S. is still quite poor, corporate profits and household net worth have hit record levels. Hopefully, all this wealth and liquidity can find their way into a new wave of profitable investment opportunities and significantly augment improvements in the current economic recovery. For investors who see a virtuous cycle of employment, consumption, and investment in the works, the continued outperformance of growth stocks over value stocks could remain the prevailing trend, favoring the iShares Russell 1000 Growth Index (IWF), and growth-oriented companies such as Google (GOOG) or Apple (AAPL).

Equity outlook: Cautious 

Given the China- and Russia-related uncertainties, investors may wish to consider limiting excessive exposure to broad equity markets, as reflected in the iShares Russell 2000 Index (IWM), State Street Global Advisors S&P 500 SPDR (SPY), Dow Jones SPDR (DIA), and iShares S&P 500 (IVV). Accordingly, investors may wish to consider shifting equity exposure to more defensive consumer staples–related shares, as reflected in the iShares Russell 1000 Value Index (IWD).

Continue to Part 6

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