Small Business Economic Trends - November 2010

Optimism Index
Optimism rose again in October to 91.7, but remains stuck in the recession zone established over the past two years, not a good reading even with a 2.7 point improvement over September. This is still a recession level reading based on Index values since 1973. However, job creation plans did turn positive and job reductions ceased. The mood for inventory investment weakened a bit even though views of inventory adequacy improved, and an improvement in sales trends produced a marked improvement in profit trends, still ugly, but less so by a significant amount.

Labor Markets
Average employment gorwth per firm was 0 in October, one of the best performances in years. Reaching the "0" change level raises the odds that Main Street may contribute to private sector job growth for the first time in over a year. Ten percent (seasonally adjusted) reported unfilled job openings, down one point and historically very weak. Over the next three months, eight percent plan to increase employment (unchaged), and 13 percent plan to reduce thir workforce (down three points), yielding a seasonally adjusted net one percent of owners planning to create new jobs, a four point gain from September.

Capital Spending
The frequency of reported capital outlays over the past six months rose two points to 47 percent of all firms, three points above the 35 year record low. Of those making expenditures, 32 percent repoteding spending on new equipment (up two points), 16 percent acquired vehicles (up one point), and 12 percent improved or expanded facilities (up two points). Three percent acquired new buildings or land for expansion (down one point) and nine percent spent money for new fixtures and furniture (down one point). Not great, but showing some strengthening tendencies. The percent of owners planning capital outlays in the future fell one point to 18 percent because the environment for capital spending is not good.

Inventories and Sales
The net percent of all owners (seasonally adjusted) reporting higher nominal sales over the past three months improved four points to a net negative 13 percent, 20 points better than May 2009 (the recession bottom). The net percent of owners expecting higher real sales gained four points from September, rising to a net one percent of all owners (seasonally adjusted). Small business owners continued to liquidate inventories and weak sales trends gave little reason to order new stock. A net negative 16 percent of all owners reported gains in inventories (more firms cut stocks than added to them, seasonally adjusted), two points worse than September.

Inflation
The downward pressure on prices appears to be easing as more firms are raising prices and fewer are cutting them. Seasonally adjusted, the net percent of owners raising prices was a net negative five percent, a six point increase from September. Plans to raise prices rose five points to a net seasonally adjusted 12 percent of owners. However, most plans to raise prices have been frustrated by the recession and weak sales during the past few years. On the cost side, four percent of owners cited inflation as thier number one problem and only three percent cited the cost of labor, so neither labors costs or materials costs are pressuring owners to raise prices. If "pricing power" is making a comeback, owners will begin to see a reversal of rather adverse profit trends.

Profits and Wages
Reports of positive earnings trends posted a seven point improvement in October, registering a net negative 26 percent. Still, far more owners report that earnings are deteriorating quarter on quarter than rising. Of those reporting lower earnings compared to the previous three months, 60 percent cited weaker sales, three percent blamed rising labor costs, eight percent higher materials costs, three percent higher insurance costs and eight percent blamed lower selling prices. Five percent blamed higher taxes and regulatory costs. Owners continued to hold the line on compensation, with seven percent reporting reduced worker compensation and 11 percent reporting gains. Seasonally adjusted, a net four percent reported raising worker compensation, only six points better than February's record low reading of negative two percent but drifting up. Labor costs are still under control, good news for those worried about inflation but bad news for workers.

Credit Markets
Overall, 91 percent reported that all their credit needs were met or that they were not interested in borrowing. Nine percent reported credit needs not satisfied, and a record 52 percent said they did not want a loan (13 percent did not answer the question and might be presumed to be uninterested in borrowing as well). Only three percent reported financing as their number one business problem. However, 30 percent of the owners reported weak sales as their top business problem, a major cause of the lack of credit demand observed in financial markets. A near record low 31 percent of all owners reported borrowing on a regular basis. Reported and planned capital spending are at 35 year record low levels, so fewer loans are needed. Those looking for loans predominately are looking for cash flow support, not funds to expand or hire. Expected sales gains are very weak, reducing the likelihood that an investment in new equipment, expansion or new workers will pay back the investment made. The percent of owners reporting higher interest rates on their most recent loan was five percent, while three percent reported lower rates. The net percent of owners expecting credit collections to ease in the coming months was a seasonally adjusted negative 12 percent (more owners expect that it will be "harder" to arrange financing), a two point improvement. Rates are low, but most owners are not interested in borrowing.

COMMENTARY

Well, not much has changed. The Index remains at recession levels where it has been for two years. Few owners expect business conditions to improve, few expect real sales to rise, more plan to cut inventories than to order more, and capital spending plans and actual expenditures remain at recession levels. However, there are few specks of good news. Firms appear to have stopped reducing employment, but few plan to create new jobs. Inventory levels are viewed as balanced, but more owners still continue to reduce stocks than build them and more plan cuts than additions. Interest rates are low, yes, but there is little motivation to borrow even cheap money since there are few uses that promise a return on their investment. Most owners (75 percent) feel it is not a good time to expand their firms (20 percent are uncertain), 1 in 5 of them blame the uncertain political environment as the primary factor explaining their views.

Unhappy shareholders voted for a major change in the management team for USA, Inc. with the hope of seeing a different set of policies implemented to "right" the ship. The old team dealt with the jobs recession by spending their time on legislation for cap and trade, card check, health care reform, union bail outs (GM and Chrysler), a "stimulus" bill that was designed not to stimulate small businesses but instead support union workers, a 10 percent increase in the minimum wage which cost half a million teen jobs, and other policies which ordinary shareholders could not understand as dealing with the immediate problems of the economy. And then there are the frighteningly large deficits and profligate states on the verge of bankruptcy with striking workers that are far better paid than their private sector counterparts.

And if that weren't enough, the day after the election, the Federal Reserve embarked on a highly doubtful policy course to expand its balance sheet to near $3 trillion by buying more Treasury bonds. Just how much spending will be stirred by, say, a quarter point reduction in rates is also unclear, but the presumption by most is "not much." With historically low rates, who hasn't already refinanced or bought a house that has the interest and ability to do so? The Federal Reserve also seems to have forgotten that thousands of smaller banks that don't have access to "cheap money" have established floors on loans and Federal Reserve action is unlikely to push through them, especially since most market participants expect rates to eventually go higher. With over a trillion dollars of excess reserves now being held for banks at the Federal Reserve, it is hard to see the 2nd round of quantitative easing "QE2" doing much other than adding to those excess reserves. If the current trillion in excess reserves can't be lent out, what's the banking system to do with another half trillion?

The private sector will continue to slog ahead, after all, the population grew by another million or more and they need food, haircuts, transportation and the like. Indeed, it is new firms started to serve population growth that accounts for a lot of the job growth in America (Japan and Western Europe are missing this source of growth). Although Congress has erected many "headwinds" for growth, the new management team may provide some relief and reduced uncertainty. This would certainly promote more growth.

This survey was conducted in October 2010. A sample of 10,799 small-business owners/members was drawn. One thousand nine hundred ten (1910) usable responses were received - a response rate of 18 percent. 

Bill Dunkelberg, Chief Economist for the National Federation of Independent Business
Copyright 2010, the NFIB retains ownership. All Rights Reserved.