Signs of Upturn in Inventories Remain Elusive

By ALEX FRANGOS and ELIZABETH HOLMES When businesses add merchandise to store shelves again and consumers gobble up the goods, the signs of an economic turnaround will have arrived. That hasn't happened yet. U.S. retail sales rose in June, but mostly because of higher gasoline prices and volatile auto sales, the Commerce Department reported Tuesday. Meanwhile, businesses continued to slash inventories. Retail sales climbed 0.6% in June from a month earlier on a seasonally adjusted basis to $342.1 billion, according to the Commerce Department. Excluding gas and autos, retail sales actually declined for the fourth consecutive month. Amid high unemployment and stagnant wage growth, consumers' thriftiness is likely to persist in the second half of the year, even as some economists predict the economy will begin to grow again. "People will continue to prioritize spending until income growth comes back -- until mid-2010 at the earliest," said Adam York, an economist at Wells Fargo. "People will have to be really careful about where they are spending." That consumer behavior is prompting retailers to keep stocks of goods low, seeking to avoid a discount bloodbath similar to the one last year, when many were forced to liquidate merchandise in order to raise cash. Such caution means that the bounce to the economy from any restocking -- which spurs production -- could be muted. Terry Lundgren, president and chief executive of Macy's Inc., said he doesn't expect a repeat of the panic promotions of last year, because supply and demand are "relatively at parity again." "There will not be the same level of promotions to clear inventory" as there was last year, Mr. Lundgren said. But retailers streamlining inventory ahead of the back-to-school and end-of-year holiday selling seasons are also under pressure. If they don't produce enough shiny new items, customers will remain content with their old products. If they don't stock up on enough of the new products, customers will get angry when stores run out of the popular ones. Cheryl Kehl, a 56-year-old homemaker from the Chicago suburbs, has noticed far less merchandise in stores where she regularly shops for her adult children, including Old Navy by Gap Inc. and Ann Taylor Loft by AnnTaylor Stores Corp. "It's so much sparser," Ms. Kehl said. "In some subliminal way, instead of encouraging you, it discourages you from shopping." To replenish inventories more quickly and decrease costs, some sellers are narrowing their assortment of materials or customer choices. Clothing retailer Aeropostale Inc. has cut down on the number of different fabrics it uses. The thermal fabric for some of its T-shirts, for example, is also used in hooded shirts and dorm apparel. By having a smaller range of fabric, Aeropostale can be more flexible in the use of its materials and restock more quickly, said Mindy Meads, the company's president. Sealy Corp., the large mattress manufacturer, has reduced its inventory by cutting out some of the choices it provides consumers, such as different quilting patterns on mattress borders. Meanwhile, companies are continuing to pare inventory, albeit at a slower rate. Businesses cut inventories 1% in May from the month earlier on a seasonally adjusted basis to $1.368 trillion, according to the Commerce Department. That follows a 1.3% decline in April. Inventories are down 8% from a year earlier. Intel Corp. said Tuesday that its inventories were down 25% since the start of the year, and that its outlook for the second half of the year has improved. Aluminum titan Alcoa Inc. told investors last week that it has reduced inventories 23% since the start of the year. The hope among more optimistic analysts is that eventually businesses -- and consumers -- will work through their stocks of goods and be forced to buy again. Socks with holes in them will need to be replaced, and empty cupboards restocked. "Low inventories will contribute to increased production, which will bring people back to work," said Robert Dye, an economist at PNC Financial Services. "The groundwork is being put in place, and we'll see that cycle re-engage" in the second half of the year. Of course, consumers may decide to darn their socks rather than buy new ones. "Household balance sheets are a wreck," said Joshua Shapiro of economic consultants MFR Inc. in New York. Some businesses said they might begin restocking soon. Rick Gold, chief executive of wireless equipment manufacturer CalAmp Corp., said his customers are beginning to wade back into purchasing again. "The inventory correction in the markets we serve is done," he said. CalAmp, based in Oxnard, Calif., had $98 million in revenue last year. It cut inventory for the fifth quarter in a row in the period ended May 31. Its stock of equipment declined by 6.5%. "Now we are seeing the demand from the end user," Mr. Gold said. Write to Alex Frangos at alex.frangos@wsj.com and Elizabeth Holmes at elizabeth.holmes@wsj.com