April 3, 2009                                 Some thoughts on recession, inventories and outsourcing

I recently talked with a former Goldman Analyst. Real nice person. The person brought out some good theories, which I would like to share. I certainly have not verified this persons theories, but they make sense to me in quick thoughts.

1. The person mentioned former boss would say the following. Watch real earnings. Last year he claimed earnings were down 8%, yet this year The person says they are up 1.8%. The person was always told to focus on the 91.9% employed and not the 8.1% unemployed. Still have lots of workers out there. Of course unemployment is likely to go up. Yet, he says the real earnings power is the item to watch. This also ties into inflation rate, which of course until potentially very recently has been deflating.

Here is a link I found which shows labor costs.

2. Sustainable Sales. The person used autos as an example. Claims for example if Autos have a 60 day supply, maybe now a 40 day supply, lower inventories are building a future pent up demand. Thinks the autos sold moving forward will naturally move up from these levels. Maybe never at old levels, but still sustainability The person thinks is higher than now.

3. I discussed with 2 above the Inventory to Sales ratio still being high. The person gave an interesting view. We know inventories are coming down, so why is Inventory to Sales Ratio increasing? The persons answer, because Revenues are decreasing. Once they stabilize and grow, then ratio will decrease. I have watched this ratio for years. I have studied that most recessions are shown with increased inventories. I have recently noticed inventories coming down and until I spoke with this person, I never thought of Inventory to Sales ratio increasing because of lower revenues. Makes perfect sense to me.
The person further clarified, “Auto inventories are down, but since sales are also down, the inventory sales ratio hasn’t changed much. If sales move back up (16mn/yr down to 9mn in January – February, yet you would think 12mn is sustainable), you would have a 33% drop in the ratio without any inventory reduction.”

Here is a link to inventory and sales http://online.wsj.com/public/resources/documents/bbinv.pdf

4. Last item was The person’s view that outsourcing overseas is turning out to be more expensive than originally thought. Difficult to monitor and control. The person claims you are now seeing when items are produced say in China, they are being used in China and not shipped back, same with Eastern Europe.

The person further clarified, “On outsourcing, rising freight transportation costs have made outsourcing to Asia for US products less attractive. The need for greater inventories when you have a global supply change has a higher cost with credit tight. The need to manage a more complex operation have all made outsourcing returns less attractive than originally thought. If you want to outsource in US, you would more likely go to Mexico, and if in Europe, more likely go to Eastern Europe. The fact that US productivity continues to climb and real wages are falling has also made outsourcing less attractive.”
Here is a cool link I came across as I was creating this note