When you think about a shrinking economy, what comes to mind?

Factories shutting down. A wave of job losses and few open positions. Huge financial losses that batter most industries.

That's not what America is seeing right now, even though the country's gross domestic product has declined for two consecutive quarters, meeting one technical definition of a recession.

So what is happening, and where could we be headed? The answer to both questions could be found in the country's stockrooms.

Breaking it down: US GDP for the second quarter fell at an annualized rate of 0.9%, according to the first reading from the Commerce Department published Thursday. That followed a contraction of 1.6% during the first three months of the year.

The data stoked debate about whether the United States is already experiencing a recession, which economists have warned is a risk as the Federal Reserve hikes interest rates and inflation curbs consumer spending.

Fed Chair Jerome Powell, for one, doesn't think this moment has arrived — at least not yet.

"I do not think the US is currently in a recession," Powell said earlier this week. "There are just too many areas of the economy that are performing too well."

But GDP doesn't just turn negative on its own, and Thursday's data contains useful guidance for understanding a complex economic moment.

Pay attention: Inventories, or goods held by a business that haven't been sold yet, had a major role to play.

Companies stocked up on many items late last year as they attempted to dodge supply chain problems and ensure they could meet resurgent demand. But in recent months, they've realized they have too much stuff, especially at an uncertain moment for manufacturers and shoppers, and become hesitant to place new orders.

The subsequent slowdown in inventory accumulation contributed to a large chunk of the contraction between April and June, removing a whopping two percentage points from economic output.

Why it matters: Some economists and investors think that because growth was pulled forward at the end of 2021, activity in the first half of 2022 looks artificially low.

"The fourth quarter, to me, was bloated a little bit," said Anna Rathbun, chief investment officer at CBIZ Investment Advisory Services. "Everyone was just hoarding things."

But that doesn't mean inventory levels should be disregarded. In fact, they contain helpful clues when monitoring how fast the US economy could decelerate from here on out

Ed Cole, managing director of discretionary investments at Man Group, told me there's two main reasons he's closely watching the speed at which US inventories grow "as an indicator of where we are in the cycle."

If customers are buying fewer products, companies won't place new orders, which will weigh on factory output.

If companies are forced to get rid of unwanted inventory with hefty discounts, it will put pressure on revenue and profits.

"Recent warnings by large retailers have demonstrated this effect quite clearly," he added.

See here: This week, Walmart (WMT) slashed its profit outlook, warning that customers are changing their shopping habits. That's requiring markdowns to clear out excess inventories of products like clothing.

It's not the only company with this problem. American Outdoor Brands (AOBC) recently told analysts that "rapidly rising inflation and interest rates ... have served to drive up inventory levels." Hasbro (HAS) also said it had "higher-than-typical inventory levels" for this time of year, though it emphasized its stock is "extremely high quality."

Source: https://edition.cnn.com/2022/07/29/investing/premarket-stocks-trading/index.html

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