October's Business Inventory Rise Shows Continued Confidence in Recovery

Although business inventories rose a less-than-expected 0.7% in October, the tally still marked the ninth straight monthly inventory increase -- a sign that businesses continue to anticipate adequate demand in the current and immediate quarters ahead.

Equally significant, September's inventory rise was revised up to a 1.3% gain, from the initially estimated 0.9% increase.

Analysts polled by Bloomberg had expected business inventories would rise 1% in October. Inventories rose 0.9% and 1.1% in August and July, respectively.

By sector, manufacturing inventories rose 0.8%, merchant wholesale increased 1.8%, and retail decreased 0.5% in October.

A Decent Increasein October Sales

In general, economists prefer to see business inventories rise during an expansion because it historically indicates businesses are confident that increased demand will take the products off their shelves. Moreover, inventory-building and -replenishing also lead to job creation, as businesses increase production.

Sales were also up in October, climbing 1.4% to a $1.12 trillion annual rate -- up 9.3% compared to October 2009, an improvement from the 8.9% year-over-year increase recorded in August. However, economists are careful to point out that current year-over-year sales increases stem from a low base as a result of the recession, hence large gains are easier to achieve.

With sales rising faster than inventories, the inventory-to-sales ratio dipped to 1.27 in October from 1.28 in September, which translates into a 1.27-month supply of items at the current sales pace. The ratio, an indicator of demand, was 1.3 in October 2009.

The Uptrend Remains in Place

October's business inventory report provides a case study concerning why investors would be wise to probe beyond the headlines. Even though the top-line October business inventory total was slightly less than economists expected, the important theme remains: nine months of rising inventories amid decent sales. And restocking will likely put boost GDP growth in the fourth quarter, and those immediately following. In part due to the inventory restocking, third-quarter GDP was revised up to 2.5% from 2%.

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The retail inventory component provides another tell-tale stat: Aided by better-than-expected retail sales, retail inventories fell 0.5%. So, despite increased production, retail inventories aren't piling up -- which means wholesalers may have to increase production again to meet retailers' needs -- which would be bullish for job creation and economic growth.

Separately, the bullish inventory build is consistent with a November survey showing the highest confidence among small-business owners since the recession started in December 2007. The National Federation of Independent Business's optimism index increased to 93.2 in November from 91.7 in October, its highest level since December 2007.

The NFIB report is based on a survey of about 800 small-business owners, who were surveyed through Nov. 30. Small businesses -- companies employing up to 500 people -- have created about 65% of all new jobs in the past 17 years.