MacroMicro

So far this year, the U.S. economy has continued to expand on the back of AI hardware demand and a manufacturing recovery. Whether consumption — which accounts for nearly 70% of GDP — can sustain its momentum has therefore become the key to judging whether the cycle extends.
U.S. retail sales growth has rebounded markedly of late, and consumption contributed substantially to Q2 GDP growth. Mixed in, however, were one-off World Cup-related spending and nominal amounts inflated by the rebound in oil prices, which inevitably raises a question: once this short-term noise is stripped out, does underlying U.S. demand still have real support — enough to drive the next round of manufacturing restocking?
This Key Chart takes you through two indicators, the "spread between retail sales and inventory growth" and the "MM Manufacturing Cycle Index", starting from the inventory signal to pinpoint where we currently sit in the cycle.
1. Breaking down two key indicators: the gap between inventories and orders
Judging where we are in the manufacturing restocking cycle comes down to watching two signals reflected in the supply chain: the strength of inventories and of demand (that is, orders). To unpack this transmission chain, we can look at the strength of end consumption through the following two indicators:
Retail sales vs. retail inventories: Retail sales measure how much U.S. consumers spend on retail goods, making it the most direct gauge of domestic demand; retail inventories reflect stock levels at the retail end, i.e. how much merchandise distribution channels are holding and waiting to sell.The gap between sales and inventory growth (red line in the chart): Subtracting the year-on-year growth rate of the latter from the former measures the relative strength of end demand versus inventory levels. When the spread is positive and widening, demand is growing faster than inventories, and even if inventories are rising, that is most likely because strong orders are creating an incentive to restock. When the spread turns negative, inventories are growing faster than demand, meaning stock is piling up because goods are not selling.
2. The four stages of the manufacturing inventory cycle
Behind the manufacturing cycle lie the dynamic adjustments firms make across orders, production and inventories. Based on the relative changes in "demand" and "inventories", a full cycle can be divided into four stages, with the upswing and downswing each lasting roughly 1.5 to 2 years:
Passive destocking (start of the upswing): Demand recovers before firms have responded, so existing inventories are drawn down passively and new orders begin to pick up. At this point the indicator is rebounding off the bottom, while the manufacturing cycle index is usually still at a low level.Active restocking (strongest expansion): Firms recognize that demand is strong, so they ramp up production and hiring and actively rebuild inventories. The indicator holds steady at a high level and the manufacturing cycle index rises in tandem.Passive restocking (start of the downswing): Demand weakens while firms are still producing based on earlier expectations, so inventories pile up passively. The indicator slides from a high level — the most critical warning sign that the cycle is turning from boom to bust.Active destocking (cycle trough): Firms actively cut production and headcount to work down inventories, the indicator falls rapidly, and the manufacturing cycle index drops to a low level.
What distinguishes these four stages is, in every case, comparing the growth rates of demand and inventories to determine the real reason behind a change in inventories, which reduces the error involved in relying on a single indicator. As it turns out, this indicator moves in the same direction as the MM Manufacturing Cycle Index, strongly corroborating the manufacturing cycle.
MM Research
Comparing further with history lets us assess the nature of this rebound. Looking back at 2021–2022, pandemic relief and revenge spending at one point pushed retail sales growth to an extreme high of more than 50% year-on-year. Firms subsequently restocked on a large scale, driving retail inventory growth above 20% in 2022. But when sales momentum fell back while inventories kept accumulating at high levels, the economy moved from "active restocking" into "passive restocking", and from the second half of 2022 entered a destocking cycle that lasted a full year (with the red line falling sharply).
Firms have recently begun restocking across the board, and retail inventory growth has recovered to 3.38% (from 3.03%). But with consumption strong in Q2, demand is still growing faster than inventories, keeping the spread between retail sales and inventory growth in positive territory — confirming that we remain in the active restocking stage. The MM Manufacturing Cycle Index reading of 0.7 for July (from 0.52) likewise points to an upswing.
Going forward we will keep watching whether stability holds once the one-off spending has passed, and other data can serve as confirmation. The first is the Redbook Same-Store Sales Index, currently at 8.7% year-on-year in the latest week (from 8.3%), suggesting buying appetite remains steady. The second is real personal consumption expenditures: because price effects have already been stripped out, it removes the nominal distortion from higher oil prices and confirms that demand growth is coming from genuine volumes. Its latest reading is 2.54% year-on-year (from 2.39%), also climbing steadily. These consumption data will let us keep verifying whether the manufacturing cycle is holding in a strong configuration.
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