Small Business Economic Trends - June 2010

Optimism Index
The May Index of Small Business Optimism gained 1.6 points, increasing to 92.2. Not a strong signal of recovery, but it is headed in the right direction. It is the best reading since September 2008 (92.9), just before the 5.4 point decline in October. Seven of the 10 Index components increased but job creation and capital expenditure plans barely moved and remain at "recession" levels. The duration of recession readings in the NFIB survey is exceptionally long compared to the 1980-82 recession period. If this is a "V" recovery, it is "lower case."

Labor Markets
Nine percent (seasonally adjusted) reported unfilled job openings, down two points and historically very weak. Over the next three months, seven percent plan to reduce employment (unchanged) and 14 percent plan to create new jobs (unchanged), yielding a seasonally adjusted net one percent of owners planning to create new jobs, two points better than the April reading. Since the third quarter of 2009, job creation plans have seriously underperformed the recoveries from the other two deep recessions covered by the NFIB survey. Coming out of the milder 1991 recession, construction added more than 100,000 jobs and 20,000 new firms in a year's time.

Capital Spending
The frequency of reported capital outlays over the past six months was unchanged at 46 percent of all firms, two points 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 rose one point to 20 percent, four points above the 35 year record low. Five percent characterized the current period as a good time to expand facilities, up one point. However, compared to past recoveries, small business owners' expectations are far less optimistic of a solid recovery.

Inventories and Sales
The net percent  of all owners (seasonally adjusted) reporting higher nominal sales in the past three months improved four points to a net negative 11 percent, and up 14 points in the past two months. It is the best reading since April 2008. The net percent of owners expecting real sales gains lost a point, falling to a net five percent of all owners (seasonally adjusted) after a nine point gain in April. Small business owners continued to liquidate inventories and weak sales trends gave little reason to order new stock. A net negative 20 percent of all owners reported gains in inventories, eight points better than December's record liquidation reading but two points worse than in April. Plans to add to inventories improved four points to two percent of all firms (seasonally adjusted) adding to a five point improvement in April.

Inflation
The weak economy continued to put downward pressure on prices. Fourteen (14) percent of the owners (down one point) reported raising average selling prices, and 28 percent reported average price reductions (up four points). Such widespread price cutting contributes to the high percentage reporting declining sales revenues. Plans to raise prices rose one point to a net seasonally adjusted 14 percent of owners. On the cost side, four 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, so neither labor costs nor materials costs are pressuring owners.

Profits and Wages
Reports of positive profit trends improved by three points in May, registering a net negative 28 percentage points, 15 points better than May 2009. However, the persistence of this imbalance is bad news for the small business community. Profits are important for the support of capital spending and expansion. For those reporting lower earnings compared to the previous three months, 53 percent cited weaker sales, four percent blamed rising labor costs, six percent higher materials costs, four percent higher insurance costs, and six percent blamed lower selling prices. Six percent blamed taxes and regulatory costs. Owners continued to hold the line on compensation, with 10 percent reporting reduced worker compensation and 13 percent reporting gains. Seasonally adjusted, a net two percent reported raising worker compensation, only four points better than February's record low reading of negative two percent. However, labor costs still appear to be 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 NFIB borrowers, 32 percent accessing capital markets at least once a quarter, one point above the survey record low, continued to report difficulties in arranging credit. A net 13 percent reported loans harder to get than in their last attempt, down one point from April. Overall, 92 percent of the owners reported all their credit needs met, or they did not want to borrow. Very weak plans to make capital expenditures, to add to inventory and to expand operations make it clear that many good borrowers are simply on the sidelines, waiting for a good reason to make capital outlays and order inventory and take out the usual loans used to support these activities. Even if credit were free, these business owners would not spend the money to hire or make capital outlays since such expenditures have no prospect of earning their keep. Only three percent of the owners reported "finance" as their top business problem, down one point. Pre-1983, as many as 37 percent cited financing and interest rates as their top problem. What businesses need are customers, giving them a  reason to hire and make capital expenditures and borrow to support those activities. Thirty (30) percent cite weak sales as their top business problem.

COMMENTARY

The small business sector (half of private GDP and 2/3rds of new job created historically) is showing some signs of new life. The May survey delivered some actual positives - more owners gave positive responses than negatives ones to many questions than at any time in the past two years. Still, overall, the Index and its components remain in "recession" territory. The small business sector is in maintenance mode, not growth, but it has definitely lifted off the bottom with the worst survey readings behind us.

Unfortunately, Washington, D.C. and many states legislatures seem determined to undermine any economic forward momentum for small business owners. And even though small business owners continue to plead their case for policies that will help foster economic growth, many lawmakers are unwilling to listen. Small business owners keep saying that poor sales ("It's the consumer, stupid!") is their most pressing problem and the reasons they aren't interested in expanding are due to current economic conditions and the political climate. Unfortunately, Congress is fixated on credit and special favors for unionized firms, and that won't sustain or support faster growth.

A huge help in moving toward a stronger economy for small business owners would be to "do no harm." But Congress continues to pass and propose legislation that increases the cost of running a business and create huge uncertainty about future costs. The small business sector of the economy is improving, there is a pulse, but it is weak. Washington is applying leeches and performing blood-letting as a cure. Assuming Washington does not intensify its efforts to "cure" small business, the housing mess continues to correct itself. With half of the growth in Q1 accounted for by inventories, it is clear how important housing and consumer spending usually are in a recovery. These engines must get started, the inventory surge can't last much longer.

For the year (half of it is almost over!), inflation will remain low as owners continue to reduce prices to raise cash and shed inventory to stay in business. The Fed has committed to lower interest rates, for better or worse, so no problems with the cost of credit (assuming one has use for it). Job growth will be anemic, we lose 400,000 Census workers mid-year and,  if we want to restore 2007 employment levels and unemployment rates by 2013, we need a net 400,000 new jobs every month for 3 years. The inventory cycle is almost done for small businesses as existing stocks come into line with desired levels (based on rather pessimistic expectations for sales growth, unfortunately). Capital spending won't pick up, there is still excess capacity so spending will occur only for necessary repairs and replacement for most owners. Lots of small businesses in the 5 Gulf states will be harmed by the oil debacle, more "weak sales." Let's hope for a successful resolution of that problem before the next survey.

This survey was conducted in May 2010. A sample of 3,938 small-business owners/members was drawn. Eight hundred and twenty-three (823) usable responses were received - a response rate of 21 percent. 

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