Albert Edwards Spots ‘Elephant In The Room’

Albert Edwards wants to “talk about stocks.” But not those stocks.

In a Thursday note, SocGen’s incorrigible, yet generally affable, bear, addressed what I’ve variously suggested is the elephant in the room for the US economy: Inventories, or the other stocks, if you like.

As regular readers are well apprised, the prospect of excess goods inventory hung over retail earnings like stale cigarette smoke, and some have suggested associated discounting will serve as yet another margin headwind at a time when companies’ bottom lines are already under pressure from surging input costs and labor bills.

Read more: So, You’re Finally Awake To America’s Inventory Problem

“Although inventory liquidation might be good news for taking the heat out of rampant inflation, it certainly isn’t good for future GDP growth as orders will need to be slashed,” Edwards said.

He went on to note that if the inventory problem is more pervasive than consensus believes, it may “help explain why US CEO confidence has collapsed recently, something which normally precedes an investment downturn.” The figure (below) illustrates the point.

As Edwards wrote, inventory oscillations help explain the business investment cycle, and “invariably cause recessions.”

I don’t know if “invariably” is the right word, but I’d be a hypocrite if I tried to dial back or otherwise water down the message given that I’ve spent two straight weeks pounding home the exact same bearish talking point.

On Thursday, the second read on US Q1 GDP showed the economy decelerated at a slightly faster pace than initially reported. The drag from inventories was larger versus the advance read (figure below).

Edwards continued: “As was drilled into me at the BoE, it is the change in the change in inventories that contributes to GDP growth, hence despite inventories still piling up at an almost record rate, they still knocked GDP growth because [the pace] was lower than the rise in Q4.”

There were two overarching takeaways from Albert’s latest. First, an unexpected buildup in excess inventory into the teeth of a Fed tightening cycle could contribute to a recession. “The inventory elephant is still filling the room,” as he put it.

Second, too much inventory against decelerating demand suggests orders may need to be cut. That could be a headwind, and not just for the world’s largest economy, but also for the world’s second largest.

“China is likely to be especially hard hit, just [as] the authorities there are desperately trying to revive growth,” Edwards said. “While I think it is only a matter of time before the Fed capitulates, maybe it will actually be China that is forced to (re-)open the liquidity floodgates first,” he added.