Small Business Economic Trends - March 2010

Optimism Index
The National Federation of Independent Business Index of Small Business Optimism lost 1.3 points in February, fallin gback to the December reading of 88.0 (1986=100), only seven points higher than the survey's second lowest reading reached in March 2009 (the lowest reading was 80.1 in 1980:2). The persistence of Index readings below 90 is unprecedented in survey history.

Labor Markets
February marked a significant shift in the average reductions in workforce size. Employment per firm, seasonally adjusted, fell 0.13 workers, down from over 0.5 workers per firm every month for the previous fourteen months. Ten (10) percent of the owners increased employment by an average of 5.0 workers per firm, but 19 percent reduced employment an average of 3.2 workers per firm (seasonally adjusted). Over the next three months, eight percent plan to reduce employment (down two points), and 13 percent plan to create new jobs (up three points), yielding a seasonally adjusted net negative one percent  of owners planning to create new jobs, unchanged and still more firms planning to cut jobs than planning to add.

Capital Spending
The frequency of reported capital outlays over the past six months was unchaged at 47 percent of all firms, barely ahead of December's record low reading. Capital spending is on the sidelines as is the demand for loans to finance these activities. A revival of capital spending will require a significantly improved business outlook and some support from reluctant customers. Plans to make capital expenditures over the next few months were unchanged at 20 percent, four points above the 35 year record low. Four percent characterized the current period as a good time to expand facilities, down one point from January. A net negative nine percent expect business conditions to improve over the next six months, down 10 points from January and a very pessimistic reading.

Inventories and Sales
The net percent of all owners (seasonally adjusted) reporting higher nominal sales in the past three months remained negative at negative 26 percent, unchanged from January's reading. Widespread price cutting continued to contribute to reports of lower nominal sales. The net percent of owners expecting real sales gains lost three points, falling to a net zero percent of all owners (seasonally adjusted), although 31 points better than the March 2009 record low level. Small business owners continued to liquidate inventories and weak sales trends gave little reason to order new stocks. A net negative 18 percent of all owners reported gains in inventory stocks and for all firms, a net negative one percent (unchanged) reported stocks too low. So, it appears that stocks are considered to be roughly in balance relative to expected real sales volumes (which are weak).

Inflation
The weak economy continued to put downward pressure on prices. Twelve (12) percent of the owners reported raising average selling prices, but 30 percent reported average price reductions. Widespread price cutting contributed to the reports of lower nominal sales. Seasonally adjusted, the net percent of owners raising prices was a negative 21 percent, a three point decline in the net percent raising prices. Plans to raise prices rose two points 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 three percent cited the cost of labor. Neither labor costs nor materials costs are pressuring owners.

Profits and Wages
Reports of positive profit trends were three points better, registering a net negative 39 percentage points (35 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, so spending or hiring are not likely to improve until these trends reverse. Of the owners reporting higher earnings, 42 percent cited stronger sales (unchanged) as the cause and eight percent each credited lower labor costs, lower materials costs and higher selling prices. For those reporting lower earnings compared to the previous three months, 60 percent cited weaker sales, two percent blamed rising labor costs, four percent higher materials costs, two percent higher insurance costs, and seven percent blamed lower selling prices. FOur percent blamed regulatory costs. Poor real sales and price cuts are responsible for much of the weakness in profits.

Credit Markets
Regular borrowers (accessing capital markets at least once a quarter) continued to report difficulties in arranging credit. A net 12 percent reported loans harder to get than in their last attempt, a two point improvement from January. Thirty-four (34) percent reported regular borrowing, up two points from January but still historically very low. Weak plans to make capital expenditures, to add to inventory and expand operations also make it clear that many potentially good borrowers are simply on the sidelines. Owners are waiting for a good reason to make capital outlays and order inventory before taking out the usual loans used to support these activities. Nine percent of all owners reported that their borrowing needs were not satisfied, down three points from January. The remaining 91 percent of all owners either obtained the credit they wanted or were not interested in borrowing. Only three percent of the owners reported "finance" as their #1 business problem (down two points). Pre-1983, as many as 37 percent cited financing and interest rates as their top problem.

COMMENTARY

The economy peaked in December 2007. In January 2008, the Optimism Index fell three points to signal the start of the recession. Economic growth resumed 18 months later, with GDP posting positive growth in the third and fourth quarters of 2009. However, the small business sector has not "caught the wave." In part, this is because 65 percent of the 5.9 percent GDP growth rate in fourth quarter was due to a reversal of inventory reduction (for example, we produced five million cars but sold nine million). This is good for manufacturing but not the service sector as consumer spending was anemic in the fourth quarter. Absent a rebuild of inventories, there is not a lot of strength, some in exports (again, good for manufacturing) and of course government spending and hiring.

The Optimism Index has been below 90 for 17 consecutive months and below 90 in all but four months since the recession started in January of 2008. At the bottom of the 1982 recession, a net 47 percent of the owners expected improved business conditions in the coming months; in February, 56 points lower at a net negative nine percent. The news about the economy and financial markets has been positive for some time, so the source of this pessimism must be found elsewhere such as Washington D.C., the source of most business uncertainty, but also facts on the ground: 34 percent said weak sales are their top business problem and that is what business is all about.

Credit access is not a major factor holding up economic growth, at least the kind of growth we want. Many firms are desperate for suvival cash, but many will not survive even with a free goverment loan. Creating growth with bad loans was just shown to be a bad idea. Comparing credit availabililty to that which prevailed in the 2003-07 period is misleading. Underwriting standards were very weak, producing massive overextensions relative to cash flow and assets, a macro mistake we do not want to repeat. The notion that thousands of commerical banks are refusing to make profitable loans that would expand business activity is mistaken and not supported by statistics for community banks. Aggregate bank loans are down and should be. They were too large when we entered the recession. Owners will borrow when expectations that sales will rise and generate new revenue to pay for investments and new hires become positive.

Capital spending and inventory invesment plans remained historically low as did plans to create new jobs. Creid appears to be getting "easier." There are some good applicants and some parts of the economy are making headway. Inflation pressures are low, compensation gains have stalled and far more firms are cutting prices than raising them, good news for the Federal Reserve, but bad news for owners since this weakens nominal sales revenue (although input costs have moderated as well). Profits trends are terrible, undermining owner's ability to finance any aspect of growth. The private sector is struggling to get back on its feet, but receiving little encouragement from Washington, which is preoccupied with health care and higher taxes to finance unimaginable deficits.

This survey was conducted in February 2010. A sample of 3,938 small-business owners/members was drawn. Seven hundred ninety-nine (799) usable responses were received - a response rate of 20 percent. 

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