Posted by: Josh Lehner | January 27, 2022

You Can’t Buy What Isn’t For Sale

This morning we got our first look at 2021q4 GDP for the nation, and for the full year. The inflationary economic boom continues. The overall economy grew at an annualized rate of 14.3% last quarter (6.9% real, 7.4% inflation) bringing 2021 overall to 10.0% growth (5.7% real, 4.4% inflation). As our office and other forecasters were saying at the start of the year, this is the strongest economic growth the U.S. has seen since the early 1980s’ Morning in America.

Now, a key, technical contributor to last quarter’s growth was a big increase in inventories. In GDP accounting, inventories represent current economic activity that just hasn’t been sold yet to customers. In a sense this does mean the latest data maybe isn’t quite as strong as the topline numbers suggest given consumers didn’t buy all of things we made last quarter. However it’s important to keep in mind that right now the overall retail inventory to sales ratio is at a record low. We’re going to need a record inventory build to get the economic balance back to where it was pre-pandemic. The increase in inventories last quarter was a needed step in that direction.

In a normal cycle, the risks with an increase in inventories is that it may indicate businesses production plans are stronger than actual consumer demand; that in the future firms will need to hire and produce less to align with households. Thankfully that does not yet appear to be the case in today’s economy. Right now consumers have no shortage of firepower. Between booming labor income, accumulated household savings, record-setting housing and asset wealth, plus low credit/debt usage, consumers can spend if they want to. And we do want to.

However, we cannot buy what isn’t for sale. Supply chains are not broken, but they are overloaded. Even as supply chains move record volumes of goods, the economy has run into a few shortages, at least relative to consumer demand. With that in mind let’s take a quick look at two sectors where consumers really would like to buy more but are running into inventory problems: autos and homes.

First, U.S. automobile inventories are at record lows. We have the money, we would like to buy more vehicles but due to the semiconductor problems, inventories are low. The result is used car prices are up 40-50% during the pandemic. While vehicle-related components are only 7-8% of the overall basket of goods in the Consumer Price Index (CPI), their increases account for 20-25% of the increase in total prices in the past year. Now, it’s important to note that these auto-related issues certainly have contributed to high inflation, but are not the primary cause nor are they likely to reverse broader inflationary trends should auto production and inventories improve in the months ahead, as expected, even as they will weigh a bit on the topline CPI figures.

Second, the number of homes for sale nationwide and here in Oregon are also at record lows. We know demand for housing, and homeownership in particular, is very strong today. However the number of new listings into the market has been average/steady in the face of this strong demand, resulting in low inventories and rising prices.

Overall the near-term economic outlook remains strong. Despite more U.S. consumers indicating now is not a good time to buy durable goods, cars and homes, they still say they are planning on doing it. This is because we need or at least want more and we have the money. Overall we know that inflation is not costless, but the sets of challenges this expansion has brought are a better set of challenges than the jobless recoveries of recent decades. The economy will continue to work through the overloaded supply chains, and production of cars and homes will pick up.

Finally, two housing inventory notes:

First, construction activity is picking up. Permits and starts are rising, but completions are lagging as supply chain issues slow the production cycle down.

Second, Altos Research’s Mike Simonsen was recently on Bloomberg’s Odd Lots podcast. Mike’s a great housing-related Twitter follow if you’re interested in more. But he mentioned one thing that I found really interesting. It’s not just that higher interest rates can cool demand on their own, bringing some better balance between sales and inventories. He talked about how rising mortgage rates will impact inventories as when financing isn’t as cheap, buyers are less likely to keep their previous home and more likely to put it up for resale. It’s easier to carry two mortgages at a lower rate than a higher rate. Mike points to 2018 when we saw mortgage rates increase by about 1% from late-2017 to late-2018. Nationally inventories increased about 10% during this time, whereas in the Portland market inventories increased by more like 20%. Today we know mortgage rates have spiked 0.5-0.6% in the past month as the Fed pivots toward tighter monetary policy, and rates are expected to drift higher still in the coming years.

It’s always important to watch inventories as they are a key indicator of the market, but the added combo of higher rates and hopefully improved completions of new construction could provide a little relief, or a little bit better balance. That said, inventory is at record lows. Mike noted it will take years to get it back.

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