Small Business Economic Trends - August 2010

Optimism Index
The Index of Small Business Optimism lost 0.9 points in July following sharp decline in June. The persistence of Index readings below 90 is unprecendented in survey history. The performance of the economy is mediocre at best, given the extent of the decline over the past two years. Pent up demand should be immense but it is not triggering a rapid pickup in economic activity. Ninety (90) percent of the decline this month resulted from deterioration in the outlook for business conditions in the next six months. Owners have no confidence that economic policies will "fix" the economy.

Labor Markets
Ten percent (seasonally adjusted) reported unfilled job openings, up one point from June but historically very weak. Over the next three months, nine percent plan to reduce employment (down one point), and 10 percent plan to create new jobs (up two points), yielding a seasonally adjusted net two percent of owners planning to create new jobs, up one point from June and positive for the third time in 22 months.

Capital Spending
The frequency of reported capital outlays over the past six months fell one point to 45 percent of all firms, one point above the 35 year record low reached most recently in December 2009. The percent of owners planning to make capital expenditures over the next few months fell one point to 18 percent, two point above the 35 year record low. Five percent characterized the current period as a good time to expand facilities, down one point. But a net negative 15 percent expect business conditions to improve over the next six months, down nine points from June and 23 points from May.

Inventories and Sales
The net percent  of all owners (seasonally adjusted) reporting higher nominal sales in the past three months lost one point, falling to a net negative 16 percent, 18 points better than June 2009 but indivative of very weak customer activity. Widespread price cutting continued to contribute to reports of lower nominal sales. The net percent of owners expecting real sales gained a ponit over June, rising to a net negative four percent of all owners (seasonally adjusted), quite dismal. Small business owners continued to liquidate inventories and weak sales trends gave little reason to order new stock. A net negative 19 percent of all owners reported gains in inventories (more firms cut stocks than added to them, seasonally adjusted), two points better than June but still a very weak number. Inventories had been built in the expansion to satisfy the spending of a consumer that was saving virtually nothing.

Inflation
The weak economy continued to put downward pressure on prices. Twelve (12) percent of the owners (down one point) reported raising average selling prices, and 24 percent reported average price reductions (down three points). Seasonally adjusted, the net percent of owners raising prices was a negative 12 percent, a two point increase in the net percent raising prices. Plans to raise prices fell one point to a net seasonally adjusted 10 percent of owners. On the cost side, three percent of owners cited inflation as their number one problem (e.g. costs coming in the "back door" of the business) and only four percent cited the cost of labor.

Profits and Wages
Reports of positive profit trends worsened by a point in July, registering a net negative 33 percentage points, 29 points worse than the best expansion reading reached in 2005. The persistence of this imbalance is bad news for the small business community. Profits are important for the support of capital spending and expansion. Not seasonally adjusted, 18 percent reported profits higher (up two points), but 45 percent reported profits falling (down two points). Owners continued to hold the line on compensation, with eight percent reporting reduced worker compensation and 12 percent reporting gains. Seasonally adjusted, a net three percent reported raising worker compensation, only five points better than February's record low reading of negative two percent. Labor costs are still under control, one of the major factors affecting inflation pressures. In past recovery periods, compensation improved at a much faster pace than we have experienced in this recovery period.

Credit Markets
Regular borrowing gained three points from last month's record low to 32 percent accesing capital markets at least once a quarter. A net 13 percent reported loans harder to get than in their last attempt, unchanged from June. Overall, 91 percent of the owners reported all their credit needs met or they did not want to borrow, up one point. Credit may be harder to get compared to the bubble period (as it should be) and is always harder to arrange in a recession. But credit availability does not appear to be the cause of slow growth as many allege. Four percent of the owners reported "finance" as their top business problem, down two points. Pre-1983, as many as 37 percent cited financing and interest rates as their top problem. What busineses need are customers, giving them a reason to hire and make capital expenditures and borrow to support these activities. Twenty-nine (29) percent cite weak sales as their top business problem. The percent of owners reporting higher interest rates on their most recent loan was six percent, while three percent reported lower rates. The net percent of owners expecting credit conditions to ease in the coming months was a seasonally adjusted net negative 14 percent (more owners expect that it will be "harder" to arrange fincnancing), one point worse than June.

COMMENTARY

Seventy-three (73) percent of the owners report that the current period is not a good time to expand. Of those, 66 percent cite the weak economy as the main reason, but 18 percent cite the "political climate" as the source of uncertainty. This elevated level of concern has prevailed since January 2008 when Congress began debating the "stimulus" and other possible actions to deal with the economy and the government changed hands. The expiration of the Bush tax program and the implementation of the health care bill represent the two largest tax increases in modern history. Add to that serious talk of a VAT and passing cap and trade. Nothing here to create optimism about the future for business owners or consumers. Top that off with government borrowing of $1.8 trillion last year and $1.5 trillion this year and on into the future, it is no surprise that owners are fearful and pessimistic.

What's missing from the "debate" is logic. Policies should not violate common sense and logic; if they do, they are misleading and disguising a hidden agenda. Arguing tha tmore government spending and taxes are needed to re-establish optimism, confidence and growth doesn't meet the common sense test. Saving bankrupt companies to preserve union jobs doesn't make sense either. The list of these "policy inconsistencies" is long.

Bottom line, owners remain pessimistic and nothing is happening in Wsahington to provide encouragement. Confidence is lost. At least the "real variables" (hiring, capital spending and inventory investment) did not deteriorate substantially in July. The damage to the Optimism Index was done by expectations for business conditions for the second half - owners predict that the economy will not improve appreciably, at least on Main Street. Big banks and big manufacturers may be doing well, but the small firms are not. If this doesn't change soon, the success of the large firms will be imperiled as well.

Inflation is clearly not a problem, more firms are still cutting prices than raising them and credit is not an issue for most firms. There are problems for some firms whose sales have been impaired by the abrupt reduction in consumer spending that occurred in 2008Q4 that has not reversed. The saving rate is over six percent, good for the long haul but tough for firms that became accustomed to a "zero" savings rate supported by unsustainable home price appreciation and the borrowing that supported. But most "good" borrowers are on the sidelines, still waiting for a reason to seek a loan and expand their businesses.

This survey was conducted in July 2010. A sample of 10,799 small-business owners/members was drawn. Two thousand twenty-four (2024) usable responses were received - a response rate of 19 percent. 

Bill Dunkelberg, Chief Economist for the National Federation of Independent Business
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