Historically, economists have viewed inventory levels as one of several key leading economic indicators. High inventory levels signal a degree of short-term and long-term market confidence, particularly in raw ingredients and finished products with relatively perishable shelf lives, from laptops to olive oil to tennis shoes. After nearly 24 months of manufacturers and retailers actively seeking to reduce inventory levels, recent upticks in the Fed’s Total Business Inventories report renew the debate: Are inventory levels economic indicators or noise?
Why Maintaining Optimal Inventory Levels Matters
Central to the debate is the concept of the optimal inventory level. All other things being equal, companies at every link of the value chain should endeavor to maintain the perfect inventory level. It’s a true Goldilocks scenario: holding enough product to meet consumer demand without having excess supply, which incurs risk in several ways.
Idealized inventory levels allow businesses to:
- Meet customer demand and delivery deadlines – Having adequate supply allows brands to meet orders.
- Maximize manufacturing efficiency – Manufacturing adequate inventory lowers per-unit product costs in most industries.
- Forecast demand – Tracking demand and inventory turnover ratio informs production decisions.
- Streamline operational efficiency – Efficient warehousing improves product delivery times; overstock may slow operational processes.
Crucially, right-sized inventories substantially lower business risk. Having items costs money: storage costs, insurance, theft, damage, and spoilage. Most products have a perishable shelf life; technology goes out of date, clothes go out of fashion, and seasonal products like antifreeze face substantial demand volatility.
How Total Inventories Are Measured
The St. Louis Fed tracks the Total Business Inventories index, which measures the total inventory held by manufacturers, wholesalers, and retailers. It’s broken down further into subcategories, including manufacturing inventory and chemical inventory, to provide additional context to monthly inventory changes. The data is collected by three surveys:
- The Monthly Retail Trade Survey
- The Monthly Wholesale Trade Survey
- The Manufacturers’ Shipments, Inventories, and Order Survey
Additionally, the Fed tracks the Total Business Inventories to Sales Ratio, calculating how long on-hand inventory takes to turn over. This formula is perhaps more indicative of market dynamics, as it more actively portrays demand by representing inventory turnover.
The index is updated monthly and reveals short- and long-term trends that offer insight into broader economic trends—or do they?
Inventory Levels as a Leading Indicator
Many economists and supply chain professionals view aggregate inventory levels as one of the best economic indicators, and not without reason. Short-term changes in business inventories can indicate shifts in production and demand and forecast market upturns or downswings.
Rising inventories may signal slowing demand, while shrinking inventories often indicate increased demand. However, individual manufacturers also recalibrate inventory levels based on several factors, and they sometimes overcorrect. This makes inventory performance indicators a dynamic calculation in the best of scenarios.
Of course, real-world economics accounts for broader input values – market forces go beyond basic supply and demand.
Substantial research shows that inventory levels are often too cyclical and volatile to clearly predict future demand or performance. Studies like those from the Philadelphia Fed indicate businesses make inventory decisions based on production (and related) costs as much as, or more than, expected demand in the short term. This means monthly and even quarterly changes in inventory levels aren’t consistently scaled according to anticipated demand.
The 2020-2023 pandemic period and subsequent supply chain crisis illustrated how inventory levels can be very volatile in the short run. An immediate production decline in Q2 2020 caused by lockdowns and COVID-19 restrictions caused inventory levels to reach an all-time low of -2.40 in May 2020.
Less than 12 months later, anticipated demand led to an all-time high inventory level of 2.60 in December 2021, causing massive overstock issues across industries.
Total Business Inventories as a Recession Indicator
Economic predictions are more accurate as outcome timelines lengthen; if you predict a recession, you’ll be right at some point. Truisms aside, inventory levels have been a relatively consistent indicator of recessions – when recessions occurred.
In the past three recessions, Total Business Inventories reached 12-, 24-, and 36-month highs within 6 months of the recession’s official start. In 2000 and 2020, inventory levels declined by more than 2% in the three months preceding the recession. However, that 2% short-term decline occurred multiple times throughout each business cycle, including 11 times (each year) between the start of the Great Recession recovery in 2020 and the recession triggered by the COVID-19 pandemic.
Inventories Remain Stable, But Wary
US inventories were largely stable through 2024, increasing 2.4% YoY in October, with an inventory/sales ratio of 1.37, 0.01% higher than in October 2023. However, some industries reported increased levels, particularly those likely to be impacted by tariffs in 2025 and beyond; retail inventories, particularly for consumer goods, increased 0.9% MoM in October, while upstream manufacturer and wholesaler inventories declined.
Improve Inventory Management with a Smarter Distribution Partner
Even the best economic indicators get it wrong, and individual inventories are shaped as much by production capacity and inventory tracking accuracy. As your dedicated distribution partner, Tilley provides supply chain expertise, proprietary resources, and proven management systems to right-size inventory levels and make informed decisions. See why hundreds of leading suppliers and end-use manufacturers rely on Tilley Distribution for quality ingredients and bespoke supply chain solutions.
Contact us to speak with a Tilley representative today.