Hot finance topics

The news about global manufacturing is so bad, it might be good.

As factory production collapses around the world, excess inventories that stand in the way of an eventual recovery are disappearing even faster. That may allow manufacturing to stabilize later this year, providing some relief for a global economy that is contracting for the first time in six decades.

“The drop in inventories is good news,” says Ethan Harris, co-head of U.S. economic research at Barclays Capital in New York and a former economist at the Federal Reserve Bank of New York. “Just as unusually low valuations set the stock market up for recoveries, unusually low inventories set up the economy for recovery.”

The really good news, economists say, would be if stockpiles were shrinking because of greater demand for the world’s autos, earth-movers and refrigerators. There’s no sign of that: Factories around the world are making the sharpest and swiftest cuts to production ever, the International Monetary Fund says.

Caterpillar Inc. and Renault SA are drawing down their stockpiles to align excess supply with diminished demand. A JPMorgan Chase & Co. index of global inventory growth is close to an 11-year low, economist David Hensley said in a March 11 note.

In the U.S., factory inventories have fallen every month since September; in December, they dropped by 1.9 percent, the biggest monthly decline in 62 years of record-keeping. Data last week showed U.S. industrial output in February was down 11 percent from a year earlier, the biggest annual decline since 1975. The drop in the euro area in January was a record 17 percent from a year earlier.

Collapsing Trade

Spurring the cutbacks is a collapse in world trade, which is contracting the most in 80 years, according to the World Bank. U.S. industrial companies suffered what the National Association of Manufacturers calls an unprecedented drop of 20 percent or more in business investment, exports and durable- goods orders at the end of last year.

That means empty warehouse shelves and factory lots may have to stay that way, at least until the second half of the year, before things pick up.

What’s more, the process of working off the stockpiles still has a way to go, pointing to more months of economic pain and job losses. Already, 1.3 million U.S. factory jobs have disappeared since the U.S. recession began in December 2007. Akron, Ohio-based Goodyear Tire & Rubber Co., the largest U.S. tiremaker, plans additional cost savings and inventory reductions after reducing output in the last three months of 2008 by 17 million tires.

How Deep?

“While inventories bottom at the end of recessions, we don’t know how deep that bottom goes,” Harris says. “A sharp decline in inventories has little information about the timing of the recovery.”

Still, the rapid reduction is a change from previous slumps, when businesses were slow to whittle down inventories and the eventual drawdown held back recovery, says Elga Bartsch, chief European economist at Morgan Stanley in London. Now, just- in-time inventory management and closer interaction between firms at different stages of the supply chain mean companies’ stocks are in better synch with the economy, she says.

For example, Caterpillar, the world’s largest maker of construction equipment, has been allowing dealers to cancel orders as it cuts production. The goal is to match output with an expected 30 percent drop this year in demand for wheel loaders, pipelayers and other equipment.

‘A Pretty Decent Job’

“We’ve done a pretty decent job trying to keep a lid on inventory,” though “it needs to go down further,” says Mike DeWalt, head of investor relations at the Peoria, Illinois-based company.

“Manufacturers are feeling more of the pain, and until they get the inventories cleared out, they will feel a slowdown,” says Stephen Gallagher, chief U payday loans.S. economist at Societe Generale in New York.

European factories are at a similar stage, says Peter Vanden Houte, chief European economist at ING Wholesale Banking in Brussels. “Inventory reduction threatens to be a major drag on growth in the first half of the year,” he says. “There will then be some stabilization in manufacturing in the second half.”

Mark Wall, an economist at Deutsche Bank AG in London, estimates that while inventory management will reduce euro-area gross domestic product by 0.6 percentage point in the current quarter, it will add to growth in the rest of the year.

‘Far Out of Line’

“Still, the level of stocks remains far out of line with demand and will thus continue to weigh on production prospects,” he says.

Renault, France’s second-biggest carmaker, has shuttered plants and ordered temporary layoffs to slow production after plummeting consumer confidence and tighter credit led to a buildup of unsold autos.

“Inventory management and reduction will remain a priority throughout 2009,” Renault said in a Jan. 9 statement. The company, based in the Paris suburb of Boulogne-Billancourt, said it had trimmed supplies to 70,000 vehicles from more than 100,000 in September after slashing fourth-quarter production by 50 percent.

Wolfsburg, Germany-based Volkswagen AG, Europe’s largest automaker, aims to cut stocks across its nine-brand group to about 100,000 vehicles from 160,000 by the end of March. Brussels-based Solvay SA, the world’s largest soda-ash maker, is curbing output of chemicals, hydrogen peroxide, caustic soda and PVC plastic to prevent a further buildup in unsold goods.

Manufacturing Cutbacks

Cutbacks among manufacturers around the world will push global industrial production down at an annual rate of between 25 percent and 30 percent this quarter, JPMorgan Chase’s Hensley estimates. The decline should slow to between zero and 10 percent in the second quarter, he says.

Hensley says that consumer demand has firmed up in recent months, which “would set the stage for a stabilization in manufacturing and the economy towards mid-year.”

Some companies already are seeing flickers of reviving demand. FedEx Corp. last week predicted companies would start replenishing depleted inventories later this year, helping keep the economy from shrinking further. The Memphis, Tennessee-based package-shipping company is a bellwether for the U.S. economy because it delivers everything from documents to manufactured goods such as clothing and auto parts.

‘About the Bottom’

Chief Financial Officer Alan Graf said on a March 19 conference call that FedEx is unlikely to see further declines in its international air-freight business. “We think that’s about the bottom,” he said.

Tokyo-based Nippon Steel Corp. said last month output should improve next quarter because customers have used up their stockpiles. Nissan Motor Co., Japan’s third-largest automaker, said on Feb. 26 it will raise domestic production next month, while Toyota Motor Corp., the world’s largest car company, plans to increase manufacturing in May as it unveils new models.

That’s after Japanese factories cut production by 31 percent in January from a year earlier, driving unsold supplies down 2 percent in the month.

Says Norbert Ore, chairman of the Tempe, Arizona-based Institute for Supply Management’s manufacturing business survey: “It’s time to start to think the supply chain is getting control of inventories.”

Source