The Inventory/Sales Ratio And One Lousy Week For The Stock Market

What’s the big picture in economics?  That manufacturing makes things to sell at a profit.  When that isn’t happening (for whatever reason) there are problems with the economy.  During inflationary booms inventories don’t collect dust in the warehouse as demand soon takes delivery for what’s available.  So during boom times we see the Inventory to Sales Ratio (ISR) decline in the chart below. 

But booms have a way of going bust, and when they do inventories sit on warehouse shelves as sales decline, causing the ISR to rise.

Keep in mind that since 1981 inventory management was revolutionized using the Japanese method of “Just in Time” inventory control, whereby material required for production is timed to arrive at the factory just in time for assembly.  Wholesale and retail outlets have also adopted this technique, which is good for business as it doesn’t lock up a company’s cash in unsold inventory; inventory that may become a burden should the economy enter a recession.  I suspect the steep decline in the ISR since the 1980s can largely be attributed to just in time inventory management.  But some credit for this general decline must also go to the “policy makers” who have been continually inflating bubbles in some area of the economy since 1981, creating artificial demand for goods and services in the process.

Even so, businesses must still warehouse some inventory, and since 1981 changing trends in the ISR have sometimes led and other times followed big changes in the stock market.  I don’t advocate using the ISR as a market timing tool to forecast future market trends as it lacks precision.  Still, examining inventories and sales over time, via the ISR with the Dow Jones, is worth a look.

The birth of the August 1982- January 2000 stock-market bull was confirmed by a big decline in the ISR (increasing sales / declining inventories) in January 1983.  A few months late to be sure, but there it was. 

Eight months before the crash of October 1987 the ISR saw a sudden rise as declining sales resulted in rising inventories.  A good call for the ISR, and note the stock market (the Dow Jones) continued to stagnate until the ISR once again began declining in 1992.

In May 2000 we once again saw the ISR increase as sales declined and inventories piled up in the wake of high-tech bust.  However the bear market had already begun a few months earlier, so again the ISR didn’t anticipate a pending bear market, but rather confirmed it.  

It began decreasing again in September 2001 after the Dow Jones had declined 25% from its January 2000 high.  This was not a timely market call by the ISR as the Dow Jones ultimately dropped 38% from its January 2000 high thirteen months later in October 2002.  The ISR once again began declining in September 2003, a year after the sub-prime mortgage bubble began to inflate.  It didn’t bottom again until September 2008, a full year after the October 2007 market top.

We see the credit crisis in the ratio’s September 2008 to June 2009 run-up followed by its absurd June 2009 to June 2010 collapse as Doctor Bernanke medicated the economy with trillions of dollars of “liquidity injections”.  I think of this twenty-one month spike in the ISR as a fingerprint left behind by Doctor Bernanke’s “monetary policy.”

Then four years ago (since June 2011), long before the FOMC’s quantitative easing had ceased, the ISR began rising once again signaling declining sales and rising inventories.  Four years; that’s a long time for the ISR to rise without a significant negative reaction occurring in the stock market.

As I’ve said before I don’t recommend using the ISR as a market timing tool, still after examining the thirty-four years of ISR data above it can’t be denied that trends in the ISR do eventually impact the stock market and vice versa.  If the stock market has continued to advance along with the ISR over the past four years it’s because stock-market valuations have completely decoupled from economic reality as the Federal Reserve continues to “stabilize” market valuations with “injections” of monetary inflation.

But when will the stock market reconnect with economic reality?  After this week it’s hard to say it hasn’t already!  Geeze Louise, the Dow Jones has declined 1,660 points (9.16%) from its high of July 16^th, just twenty-six trading sessions ago with 1,085 of those points just this week.

But to be more specific; looking at the Dow Jones and the NYSE 52Wk Highs – Lows nets step sum below, the stock market first reconnected with economic reality earlier this summer.  The Dow Jones (Blue Plot below) managed to close above 18,000 as recently as July 20^th – just last month.  The red plot is the NYSE 52Wk net High – Low’s step sum.  As with all step sums a positive day is a +1, and a negative day is a -1 in the step sum’s total.  As you can see in the chart, over the past twenty years daily NYSE 52Wk highs have overwhelmed 52Wk lows, except during times of market distress.

Beginning on June 25^th 52Wk Lows began overwhelming 52Wk Highs for the first time in years as evident in the table below.  In the past two months only six of forty-one trading days have had more 52Wk Highs than Lows.  Note how the market bulls (the “policy makers”) goosed the Dow Jones to close above 18,000 for five days in mid-July even as the NYSE continued making more 52Wk Lows than Highs.  Five weeks later that now seems a long time ago, and breaking below Dow 16,000 now seems possible in a single day’s trading. 

Take a quick look at the NYSE data on the table’s right.  The NYSE trades around 3,200 listings daily, so seeing a few hundred 52Wk Highs or Lows, or even H-L Nets on any particular day isn’t particularly significant.   However seeing two solid months of negative NYSE H-L Nets is an early indication of a broad-based deflation occurring in the stock market.  If this continues, and I expect it will, many more of the NYSE’s 3,200 listings will soon see new 52Wk Lows.  We’ll then see four digit H-L Nets begin to appear.  Good luck trying to liquidate your position in Apple or Google then anywhere near today’s prices!

Let’s move on to the NYSE 52Wk H-L Ratio, where we take the daily 52Wk H-L Nets above and divide it by the number of shares trading each day.  I’ve plotted the results in the chart below.  Unlike the ISR, The NYSE 52Wk H-L Ratio sent an unambiguous early warning signal of a pending market crash when in August 2007, months before the Dow Jones’ October 9^th Terminal Zero (BEV speak for the last all-time high of a bull market), the ratio broke strongly below its -10% line.  This proved to be a timely indication the stock market had entered a period of broad-based deflation, which soon became the second deepest bear market since 1885. 

Using the Dow Jones as a proxy for the stock market, in August of 2008 (a year later) the market was down only 20%, not particularly significant by itself.  However when we examine the 52Wk H-L Ratio below, from the Dow’s previous all-time of 09 October 2007 through August 2008, it becomes obvious that the NYSE was being overwhelmed by 52Wk Lows.  A month later panic struck as the 52Wk H-L Ratio declined to -87.45% on the day when, for the first time since November 1974, the Dow Jones saw a 40% decline from its previous all-time high.

On October 10^th Mr Bear got everyone’s attention as the NYSE 52Wk H-L Ratio collapsed to -87.45% with 2,901 of 3,306 listings trading that day breaking down to a new 52Wk Low.  CNBC provided commercial free coverage of Doctor Bernanke, Treasury Secretary Paulson and other high-lords of “monetary policy” giving congressional testimony on the crisis.  One point all these experts seemed to agree on was that the sub-prime mortgage crisis didn’t happen as a consequence of Wall Street and Washington’s efforts to stimulate the economy following the 2000-2002 high-tech bear market.  I also seem to recall testimony from someone who attributed the credit-crisis crash to the Earth’s orbit intersecting with “beams of deflation” coming from a galaxy far, far away.  This was blithely accepted by many Members of Congress and the media at the time. 

But that was a long time ago, so my memory may be mistaken on some of the specifics from these televised hearings from many years ago.  But I also recall that Secretary Paulson demanded, and received a multi-billion dollar bazooka with which he promised to blast away at the dragon-of-deflation that threatened to take down his beloved Goldman Sachs.  Congress also granted Doctor Bernanke “new tools” to stabilize the markets.”  In retrospect it’s obvious that these “new tools” included new accounting standards which legalized formerly felonious accounting practices (as well as distorting federal statistics from the Labor and Commerce Departments), and a new monetary syringe large enough to give an elephant a proper enema.

Your mother told you never to lie, cheat or steal, so you never submitted your job application to the FOMC.  As you can see above the bazooka and “new tools” proved to be a smashing success with the NYSE 52Wk H-L Ratio once again solidly positive within two years after the crisis.  The media was happy to report that once again everything in the economy was doing well.  With the stock market once again rising, how could anything be going wrong?  Except for a few months in autumn of 2011, 52Wk Highs dominated the NYSE up until the beginning of July of this year.  Even so, the 52Wk H-L ratio hasn’t managed to break above its +10% line since last summer.  Also since March 20^th of this year when the ratio reached +8.25%, shares trading at the NYSE have found it increasingly easier to make new 52Wk Lows than 52Wk Highs.

When the NYSE 52Wk H-L ratio falls below its -30% line, that indicates the NYSE 52Wk H-L Nets dropped below -1,000 that day.

What are the chances of seeing that happen?  I’ll put it this way, if the Dow Jones once again begins making new 52Wk Lows (16,117 on the Red Plot below) for the first time since March 2009, it will do so with lots of company at the NYSE.  Look at what happened with NYSE 52Wk H-L Ratios in the chart above when the Dow Jones was making new 52Wk Lows during the credit crisis crash of 2008-09, as well as during the market mishap of September / October 2011.

Does the chart above appear bullish to you?  Look how the Dow Jones has been migrating from its last 52Wk High of May 19^th down towards its current 52Wk Low.  The exact same thing is now happening to 99% of all stocks trading at the NYSE and with the indexes in the Dow Jones Total Market Group (DJTMG).  When the Dow Jones above meets its 52Wk Low line – then what?  Does it stop or continue declining to new 52Wk Lows as the DJTMG’s Non-Ferrous Metal Miners have done since last October (below).

I sorted the DJTMG data in the table below by its Blue 52Wk Low columns.  The first twenty groups (at 0.00%) indicate new 52Wk Lows.  The percentages seen in the Green High column lists their declines from their 52Wk Highs.  Groups #21 to #44 are less than 10% from a new 52Wk Low.  The Dow Jones serves as good a proxy for the general stock market.  However this table for the DJTMG actually provides a better overall view of the market, and in the past few months market valuations have deflated significantly.

As the future is forever hidden from us by the hand of God, it’s impossible for us to know with certainty what is to come, but looking at my tea leaves (the ISR and NYSE 52Wk High & Low data above) I feel comfortable predicting a continuation of falling stock market prices in the months and years to come.  In other words; Mr Bear is returning to finish what he started during the credit-crisis crash – taking the Dow Jones down until it once again sees a dividend yield above 6%.

The table below prices the Dow Jones by its dividend payout and yield.  The top line shows Friday’s closing data.  The second line shows what happens if Mr Bear takes down the Dow Jones to a 6.00% yield while maintaining its current dividend payout of $426.20.  But as American corporate management is currently loading their balance sheets with debt in order to fund share buy-back programs, I doubt the Dow Jones, or most dividend paying stocks, will be able to maintain their current payout in an economic downturn.  So the third line prices the Dow Jones with a 50% reduction in dividend payout and an 8.00% dividend yield. Even this may prove to be optimistic should we see a full scale bond market crash – which it inevitably will.  The Federal Reserve have had their meat-hooks in the bond markets for decades, the day is coming when we’ll all see the error of that. 

By this time it should be apparent I’m expecting a repeat of the Great Depression market collapse.  To see what a 90% market decline would look like here’s a Bear’s Eye View (BEV) chart of the Dow Jones from 1885 through the close of this past week.  The survivors of the depressing 1930s never forgot the experience.

So don’t be expecting me to recommend “buying the dip” because currently I’m a sell into strength guy, and will continue to be until the Dow Jones sees it dividend yield rise substantially above 6%.  I believe that stocks will be a lot cheaper before this is over.  But markets never go down in a straight line, so expect some good days and weeks along the way down to the bottom.

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