Wars, Price Shocks, and Inventories

• US private sector inventory ratios declined steeply from the early 1980s but surged during periods of inflation and commodity price shocks (1960s-1970s energy crises, mid-2000s commodity surge)
• Manufacturing firms are expected to be most affected, with factory-level inventory holdings likely to rise sharply as they buffer against input cost volatility and supply chain disruptions
• Higher inventory levels will increase capital costs and reduce economic efficiency, likely resulting in elevated and more volatile inflation and interest rates compared to the globalization era, while potentially driving manufacturing relocation to the US due to its secure energy supplies

Summary: Wars, Price Shocks, and Inventories

Key Context:

Following the reported US-Israeli conflict with Iran launched February 28, Confluence Investment Management predicts significant shifts in corporate inventory strategies with long-term economic implications.

Main Thesis:

The war will likely spur companies to rebuild inventory levels as a hedge against supply disruptions and price volatility, reversing a decades-long trend of lean, just-in-time inventory management.

Historical Data:

• US private sector inventory ratios declined steeply from the early 1980s following Federal Reserve rate hikes and deregulation
• During the 1960s-1970s energy crises, inventory holdings jumped approximately 1% of GDP
• After 2005 commodity price surges, inventories climbed to nearly 14% of GDP before the housing crisis
• Manufacturing sector has driven most inventory ratio increases since the early 2000s

Market Implications:

• Manufacturing will be most affected, particularly regarding input and component stockpiling
• Higher inventory levels will increase capital requirements and costs for manufacturers
• Stock valuations will favor companies demonstrating superior inventory management
• Foreign manufacturers may relocate production to the US, given America's net energy exporter status and secure commodity supplies
• Commercial warehouse owners could benefit from increased storage demand
• Overall economic efficiency will decline compared to the globalization era

Broader Economic Impact:

The analysis suggests this trend will extend globally, resulting in higher and more volatile inflation and interest rates compared to recent decades, as the shift reflects wider geopolitical changes including declining US hegemony and increased international tensions.