Small Business Economic Trends - September 2010

Optimism Index
The Index of Small Business Optimism gained 0.7 points in August, rising to 88.8. Most of the improvement was accounted for by gains in expected real sales and expectatoins for business conditions six months out, the two components that lowered the Index in July.

Labor Markets
There is no life in the jobs market. The Bureau of Labor Statistics (BLS) reported 67,000 new private sector jobs in August, but 45,000 were from education and health care which are heavily dependent on government spending, not exactly "Main Street" companies. Eleven (11) percent (seasonally adjusted) reported unfilled job openings, up one point from July but historically very weak. Over the next three months, eight percent plan to increase employment (down one point), yielding a seasonally adjusted net one percent of owners planning to create new jobs, down one point from July but positive for the fourth time in the last 22 months.

Capital Spending
The frequency of reported capital outlays over the past six months fell one point to 44 percent of all firms, again hitting the 35 year record low. The environment for capital spending is not good. Interest rates are low but the record long recession has eroded financial strength. More importantly, the prospects that investment spending and/or hiring will somehow increase profits are low. Four percent characterized the current period as a good time to expand facilities, down one point. A net negative eight percent expect business conditions to improve over the next six months, seven points better than July, but still more owners expect the economy to weaken than strengthen. Owners do not trust the economic policies in place or proposed, fear the economic implications of massive deficits are distressed by global and national developements that make the future more uncertain.

Inventories and Sales
The net percent  of all owners (seasonally adjusted) reporting higher nominal sales in the past three months was unchanged from July at a net negative 16 percent, 18 points better than June 2009 byut indicative of very weak customer activity. Small business owners continued to liquidate inventories and weak sales trends gave little reason to order new stock. A net negative 15 percent of all owners reported gains in inventories, four points better than July but still very weak. Inventories had been built in the expansion to satisfy the spending of a consumer that was saving virtually nothing. August 2010 is the 29th negative double digit month in a row and the 39th negative month in a row for inventory reductions. Inventories at the "big" firms may start to accumultae as orders from small firms (many of whom are the final interface with the consumer) weaken.

Inflation
The weak economy continued to put downward pressure on prices. Seasonall adjusted, the net percent of owners raising prices was a negative eight percent, a four point increase from July. August is the 21st consecutive month in which mor eowners reported cutting average selling prices than raising them. Widespread price cutting contributes to the high percentage reporting declining sales revenues. Plans to raise prices were unchanged at a net seasonally adjusted 10 percent of owners. On the cost side, three percent of owners cited inflation as their number one problem and only four percent cited the cost of labor, so neither labor costs or 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 improved three points in August, registering a net negative 30 percentage points, 26 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 (unchanged), but 42 percent reported profits fallins, a three point improvement from July. 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
A near record low 31 percent of all owners reported borrowing ona regular basis, which is then not surprising that reported and planned capital spending are 35 year record low levels. Those looking for loand predominately are looking for cash flow support, not funds to expand or hire (see Small Business Credit in a Recession, 12/09). A net 12 percent reported loans harder to get than in their last attempt, one point lower than July. Overall, 91 percent of the owners reported all their credit needs met or they did not want to borrow, unchanged from July. Only four percent cited financing as their top business problem. What businesses need are customers, giving them a reason to hire and make capital expenditures and borrow to support those activities. 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 ocming months was a seasonally adjusted negative 14 percent (more owners expect that it will be "harder" to arrange financing), unchanged from July. 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

The Index has been below 93 every month since January 2008 (32 months), and below 90 for 25 of those months, all readings typical of a weak or recession-mired economy. Near the beginning of the recessions in 2008, USA Inc. shareholders elected a new CEO and management team, but unfortunately the change in leadership did nothing to curb the recession. In fact, the economy only got worse while new policy tactics enacted by management made little sense in terms of dealing with the main problems. Now, the shareholders are more than restless and unnerved by what they see coming out of Washington. New solutions to the problems continue to be announced, but confidence in management is very low and continues to decline. The next shareholder meeting, many board members will be gone, replaced with a new set of ideas and focus.

As a result, spending is in "maintenance" mode, replacing vehicles or equipment only as needed and hiring only for replacement purposes, therefore little growth in the economy. Spending (financed with credit or out of cash) for new equipment, expansion or for new employees must generate enough additional value to pay off the "investment" but the current environment, with weak consumer spending, offers few such opportunities. Over the last two years, record highs of nearly 1/3 of all owners continue to report weak sales as their top  business problem. Reports of quarter to quarter declines in sale outnumber reports of gains by 16 percentage points. This has characterized conditions for the past two years. Seventy-three (73) percent of owners feel it is not a good time to expand (18 percent of these blame the political climate), 21 percent are uncertain. Only 4 percent think it is a good time to expand and in some parts of the U.S. or in some industries, this is probably the case.

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. "Double Dip?" Fundamentally, the economy is set for growth, with a one percent increase in the general population (who eat, need housing and transportation) and more stuff is wearing out in need of replacements. But there is always the risk of another serious policy mistake in Washington or other events that will cause consumers to save even more  and defer purchases. Those events could produce more negative growth, but this is hard to predict. Assuming no new surprises, there is still enough uncertainty out there to digest and insure that growth will remain sub-par for some time to come and the unemployment rate will stay on the high side of 9.5 percent. It could have been much different with a different set of policies.

This survey was conducted in August 2010. A sample of 3,938 small-business owners/members was drawn. Eight hundred and seventy-four (874) 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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