Restocking the Shelves of Economic Recovery

• By KELLY EVANS

Investors, take heart. This isn't the beginning of the end of the U.S. inventory cycle. Rather, it is the end of the beginning.

Destocking—the recession-induced paring back of inventories—has largely come to an end. The slowing of that process already has delivered a significant boost to U.S. gross-domestic-product growth, adding 3.8 percentage points to the fourth-quarter 5.6% increase and a similar proportion in the first.

Now, firms are starting to boost inventory to keep pace with rising demand. On Friday, the Commerce Department is expected to say business inventories rose in April by 0.5% from March, the sixth gain in seven months.

Previously, such inventories declined for 12 consecutive months.

Investors may be underestimating the potential for gains in this second chapter of the restocking story. At the moment, inventory levels economy-wide are flirting with historic lows. For both businesses and wholesalers, the ratio of inventory to sales is at its lowest level since the series began in 1992. Meanwhile, the Institute for Supply Management's manufacturing survey last month showed 41% of customers reported that inventories were "too low"—the second highest reading since 1997.

To be sure, companies have steadily improved inventory-management techniques over the years and rely more than ever on "just-in-time" delivery.

Still, managers know well that the only thing worse than getting caught with too much merchandise is not having enough. At Talbots Inc., for example, inventories fell 18% in its quarter ended May, which analysts said left the retailer short on merchandise, resulting in missed sales.

As companies further ramp up inventory levels, it should benefit railroads, shippers, large industrial manufacturers like Honeywell and even midsize banks that lend to businesses, says Morgan Stanley.
And though this continued restocking mightn't provide as large a near-term boost to GDP, it should be a more lasting one than the fillip seen in recent quarters. Inventories rose for nearly a decade straight after the 1990-91 recession, for example, and contracted only once during the 2002-2007 expansion, according to Deutsche Bank. Moreover, the broader activity this generates should provide additional employment and income growth.

Restocking alone can't power the recovery, but it should be enough to keep up the momentum.
 
Write to Kelly Evans at kelly.evans@wsj.com