Why inventory to sales ratio is a laggin indicator?

CFA Level I
#1

Hi,

While I was studying business cycles it came to my mind that the inventory to sales ratio represent expectations about economic activity. For example, when an economy is in a recessionary trough inventories may become depleted more quickly once sales growth begins to anticipate the expansion, meaning that the ratio will be lower and that a recovery for the economy is coming. Wouldn’t this be a leading indicator instead of a lagging one?

Please correct me if I’m wrong or I misunderstanding the concept,

Thanks in advance and best regards,

#2

The inventory is the lagging number.

  • When the economy is at the peak, although sales may be slowing down, the manufacturer will have to keep producing to utilize their capacity, thus higher inventory (lags) => leading to a higher than average inventory/sales ratio

  • When the economy is near the bottom, sales is starting to pick up, but manufacturer is reducing their inventory (lags) => leading to a lower than average inventory/sales ratio