Small Business Economic Trends - October 2010

Optimism Index
The Index of Small Business Optimism gained 0.2 points in September, rising to 89.0. The increase is certainly not a significant move, but at least it did not fall. Still, the Index remains in recession territory. The downturn may be officially over, but small business owners have, for the most part, seen not evidence of it.

Labor Markets
Eleven (11) percent (seasonally adjusted) reported unfilled job openings, unchanged from August and historically very weak. Over the next three months, eight percent plan to increase employment (unchanged), and 16 percent plan to reduce their workforce (up three points), yielding a seasonally adjusted net negative three percent of owners planning to create new jobs, down four points from August. The decline in hiring plans is an unexpected reversal in job creation prospects. Hiring plans continue to underperform the recoveries following previous recessions.

Capital Spending
The environment for capital spending is not good. The frequency of reported capital outlays over the past six months rose one point to 45 percent of all firms, one point above the 35 year record low. Six percent characterized the current period as a good time to expand facilities, up two points, but historically low. A net negative three percent expect business conditions to improve over the next six months, a five point improvement from August, but still more owners expect the economy to weaken than strengthen.

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 17 percent. The reading is 17 points better than June 2009 (the recession bottom) but still indicative of very weak customer activity. Unadjusted, 23 percent of all owners reported higher sales (last three months compared to prior three months, down two points) while 34 percent reported lower sales (up one point). Overall, it does not appear that sales trends are yet supportive of a recovery in teh small business sector. The net percent of owners expecting higher real sales lost three points from August, falling to a net negative three percent of all owners (seasonally adjusted) - a dismal outlook. Hiring and capital spending depend on expectations for growth in future sales, so the outlook for improved spending and hiring is not good.

Small business owners continued to liquidate inventories and weak sales trends gave little reason to order new stock. A net negative 14 percent of all owners reported gains in inventories, one point better than August but still very weak. September is the 30th negative double digit month in a row and the 40th negative month in a row for inventory reductions.

Inflation
The weak economy continued to put downward pressure on prices. Seasonall adjusted, the net percent of owners raising prices was negative 11 percent, a three point decline. September is the 22nd consecutive month in which more owners reported cutting average selling prices than raising them. Plans to raise prices faded three points to a net seasonally adjusted seven percent of owners. On the cost side, four percent of owners cited inflation as their number one problem and only three percent cited the cost of labor, so neither labor costs nor materials costs are pressuring owners to raise prices. With no pricing power and real sales volumes weak, profits are not able to recover.

Profits and Wages
Reports of positive profit trends deteriorated three points in September, 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. Owners continued to hold line on compensation, with seven percent reporting reduced worker compensation and 10 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, good news for those worried about inflation but bad news for workers. In past recovery periods, compensation improved at a much faster pace than we have experienced in this recovery period.

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 53 percent said they did not want a loan. Only three percent reported financing as their #1 business problem. However, 30 percent of the owners reported weak sales as their top business problem. The historically high percent of owners who cite weak sales means that investments in new equipment or new workers are not likely to "pay back" and thus loans taken to finance the outlays can't be repaid.

A near record low 33 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. Sounds like weak credit demand. Those looking for loans predominately are looking for cash flow support, not funds to expand or hire. The percent of owners reporting higher interest rates on their most recent loan was 5 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 negative 14 percent, unchanged from August. The Federal Reserve is holding rates at historically low levels, but this is not improving the outlook for the ease of financing expansion. Sales are needed, not just low rates.

COMMENTARY

Members of Congress fled with no action on important issues like expiring tax rates, leaving the cloud of uncertainty larger and darker. In response, consumer sentiment fell and owner optimism remained anchored solidly in recession territory. Thus, spending stayed in "maintenance mode," deterioration of jobs continues, and capital spending remains at historically low rates. Owners won't make spending commitments when sales prospects remain weak and important decisions such as tax rates and labor costs remain so uncertain.

Inflation? Not a threat. Far more owners have cut prices than raised them for 21 months in a row. Deflation? It certainly feels that way to a quarter of the owners reporting price declines for the goods and services they produce and sell, and apparently a majority at the Federal Reserve are now worried. New "inflation targets" are being floated out there, like two percent (characterized as price stability?).This will be the justification for more "quantitative easing." Buying more Treasury securities may push rates even lower, but to what end? The impact on home sales will surely be minimal. With mortgage rates at record low levels already, even lower rates are unlikely to invite new entrants to the market. Of course, there may be other "agendas" such as a weakening of the dollar and support for asset prices. This is very dangerous as hundreds of billions of dollars are being "allocated" based on false prices (interest rates). The charade can't be maintained forever and weaking the dollar only invites others to join the party. And lost in all of this focus on credit is the loss of hundreds of billions in interest rate income for savers. Certainly their spending has been curtailed as a result. Every dollar a borrower saves from some sort of refinance deal is a dollar of interest income lost to savers. Even lenders will lose income as loans with interval rate re-sets will be set based on historically very low Treasury rates (lowering net interest margins). No wonder confidence is low and uncertainty is high, it is hard to make sense of this.

"Double Dip"? Technically, this can't happen as the recession officially ended in June 2009. New weakness would produce a new recession, perhaps like the 1980-82 period. Fundamentally, the economy is positioned for growth, with a one percent increase in the general population (which eats, needs housing and transportation) and more stuff wearing out in need of replacement. But there is always the risk of another serious policy mistake in Washington or other events associated with the "de-leveraging" of financial institutions and consumer balance sheets that could raise fear levels among owners and consumers, reducing spending further. A "lame duck" session for Congress is an uncertainty generator, as is the coming election. Resolving uncertainty will be helpful.

This survey was conducted in September 2010. A sample of 3,938 small-business owners/members was drawn. Eight hundred and forty-nine (849) usable responses were received - a response rate of 22 percent. 

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