While investors lose sleep over a possible recession, they should also be paying careful attention to inventory levels of companies as a near-term risk to corporate profits.

U.S. business inventories are back to pre-pandemic trends, according to a new analysis from Evercore ISI strategist Julian Emanuel (see first chart below). Meanwhile, inventories for Russell 1000 consumer names have increased by more than $80 billion in total since the end of 2019 (see second chart below).

"Risks are rising as momentum in goods-led consumption may be waning and a shift to services spending is underway," Emanuel explained. "Moreover, the quantity of goods sold tends to slow when inflation rises. Consumption of goods has been driven by inflation since 2021 as real consumption flatlines, burdening corporates relying on volume rather than pricing. Consumption and rising cost pressures could challenge companies that have built inventories ahead of demand."

Two of the most prominent inventory builds coming out of the first quarter could be seen at Walmart and Target.

Both major retailers saw inventories balloon by more than 30% in the first quarter, reflecting price increases by vendors but also consumers pulling back on discretionary purchases like home goods.

Walmart noted general merchandise markdowns were $100 million greater than expected.

"Most of the increased inventory and related costs were related to buying over the past several quarters with a keen focus on in-stock, and now we're in a short period of rightsizing it," Walmart CFO Brett Biggs told analysts on an earnings call. "The current sales strength and warmer weather in the U.S. give us confidence in our ability to work through this fairly quickly and strategically."

Target, for its part, warned last week it would take aggressive markdowns to clear slow-moving inventory.

"We actually do see a continued strong sales environment, [and] traffic and the top line continue to be strong," Target CFO Michael Fiddelke told Yahoo Finance recently. "But over the past several weeks, what we have been able to continue to assess is the broader retail environment — and I think as has been reported pretty widely at this point — the level of inventory in retail is high. And we also expect inflation and higher costs to be persistent."

Analysts think that it will take several quarters for retailers such as Walmart, Target, Kohl's, and others to work through their excess inventories, further pressuring margins in the process.

"While clearly a negative for Target," Citi retail analyst Paul Lejuez wrote in a note, "this is a bad development for the retail industry generally, particularly those that play in categories where Target is most over-inventoried, which are seemingly home and apparel."

Brian Sozzi is an editor-at-large and anchor at Yahoo Finance. Follow Sozzi on Twitter @BrianSozzi and on LinkedIn.

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