Small Business Economic Trends

NATIONAL FEDERATION OF INDEPENDENT BUSINESS

January 13

(Based on 805 respondents to the DECEMBER survey of a random sample of

NFIB’s member firms, surveyed through 12/29/08)

William C. Dunkelberg, Chief Economist

OVERVIEW

            >>  Optimism – second lowest in 35 years

            >>  Reports of sales declines hit survey record high

            >>  Inflation – the bottom drops out of prices, finally

            >> Job creation plans go negative, 3^rd lowest in history

            >> Job openings low but steady, a good sign

            >> Compensation cuts record high, compensation gains record low

            >> Capital spending falls, plans second lowest reading

December was not a good month, ending a quarter that will show the largest decline in real GDP since the second quarter of 1980 (our guess is a -5% annual growth rate). The Index of Small Business Optimism fell 2.6 points to 85.2 (1986=100), the second lowest reading in the 35 year history of the survey (the Index fell to 80.1 in 1980:2).  Only one of the Index components actually improved, but not significantly, two were unchanged.    Expected business conditions 6 months from now posted the largest decline (down 11 percentage points), although the average for the quarter is significantly more positive than for the first half of the year.  The percent of owners expecting real sales volumes to decline, reporting favorable profit trends and planning to make capital outlays each posted 4 point declines.  Owners, particularly retailers who make their year in the fourth quarter, were hoping that consumers would once again ride to the rescue.  It didn’t happen.   Profit trends are terrible, and since 80 percent of small business costs are typically compensation costs, owners had no choice but to trim jobs.

Inflationary pressures evaporated, with the net percent of owners reporting higher average selling prices plunging to a net negative 6 percent, more firms cut prices than raised them (down 6 points from November).  Just 6 months ago in July, a net 32 percent reported raising average selling prices!  Obviously, the widespread decline in sales is taking its toll on pricing power, good news for the inflation watchers, bad news for profits (reports of profit declines are at record levels).

[NOTE: the term “net” means that the percent of owners giving an unfavorable answer has been subtracted from the percent of owners giving a positive or favorable response.]

THE INDEX OF SMALL BUSINESS OPTIMISM AND ITS COMPONENTS

[Column 1 is the current reading, column 2 the change from the prior month, column 3 the percent of the total change in the Index accounted for by each component; “--%” means the percent <1% or not a meaningful calculation.  Index is based to the average value in 1986, components are not]

The four “hard” components of the Index took a hit (down 4 points), led down by a big decline in job creation plans.  The “soft” components posted a 24 point decline.  This does not auger well for real GDP and job growth in the first quarter of 2009.  After plunging 12 points in April, 1980, the Index bounced back 15 points in the July,1980 survey 3 months later and the economy rebounded.  Unless there is a solid turnaround in the Index in January, we are in for a longer than usual recession period. 

LABOR MARKETS:

Seasonally adjusted, there was a decline in average employment per firm of 0.86 workers reported by small business owners in December, the largest monthly decline in survey history.  Eight percent of the owners increased employment by an average of 3.2 workers per firm but 26 percent reduced employment at average of 4.2 workers per firm (seasonally adjusted).  The private sector is very weak, with the only job growth coming from education, health care and government (e.g. “government”). 

Forty percent of the owners hired or tried to hire (down 3 points from November, down from 57 percent in September, 2007) and 75 percent of those trying to hire reported few or no qualified applicants for the job openings they were trying to fill.  Seven percent of the owners reported that the availability of qualified labor was their top business problem, down from 17 percent in September, 2007.  Fourteen percent (seasonally adjusted) reported unfilled job openings, unchanged from October (the 34 year average is 22 percent), good that this important determinant of the unemployment rate did not decline in the fourth quarter.  This “core” level of job openings seems to be held hostage to a lack of qualified applicants (and regional mismatches between openings and available workers).  However, weaker hiring plans will push the unemployment rate over the 7% mark.  

Over the next three months, 8 percent plan to create new jobs (up 2 points), and 19 percent plan workforce reductions (up 2 points), yielding a seasonally adjusted net negative 6 percent of owners planning to create new jobs, the third lowest reading in survey history.  Lower readings occurred only in the 1974-5 and the 1980-82 recession periods.  Not seasonally adjusted, job creation plans were negative in all industries except non-professional services where 20 percent of owners plan to increase employment and only 8 percent plan reductions.  More owners plan work force reductions than plan to increase employment in all 9 Census regions.  The small business economy is weak everywhere.

CAPITAL SPENDING:

The frequency of reported capital outlays over the past six months fell 5 points to 51 percent of all firms as owners defer any project not essential to the survival of the firm (and consequently loan demand is lower).  Thirty-six percent reported spending on new equipment (down 2 points), 21 percent acquired vehicles (up 2 points), and 11 percent improved or expanded their facilities (down 2 points). Four percent acquired new buildings or land for expansion (down 1 point) and 9 percent spent money for new fixtures and furniture (down 5 points).  There is a “pulse” but no push and the pool of deferred projects continues to grow.  Once optimism returns, capital expenditures could surge as owners scramble to take advantage of low borrowing rates and to prepare for the return of customers.

Plans to make capital expenditures over the next few months fell 4 points to 17 percent, lower only in the 1974-5 period.  In this uncertain environment, owners are postponing any capital projects that are not essential to the operation of the firm (or that they can’t afford or can’t finance).  Seven percent characterized the current period as a good time to expand facilities, unchanged from November, but historically low.  A net negative 13 percent expect business conditions to improve over the next six months, an 11 point decline from November, but much more positive (less negative!) than during the first half of 2008 (or than the record low of negative 37 reached in 1980). 

Consumers did not ride to the rescue in the fourth quarter as many had hoped.  The savings rate increased (i.e. consumers spent less), and net credit extensions fell, a rare event.  Expectations for gains in real sales gave up 4 points, falling to a net negative 18 percent expecting improvements (one of the worst readings in survey history, but better than the negative 23 percent reading in 1980:2).  All in all, a very poor environment for capital spending, lots of reasons for delay and no need to finance new inventory with sales falling. 

Reports of positive profit trends were not supportive of capital spending either, with reports of profit gains deteriorating another 4 points to a negative 42 percentage points, a record low.  A year ago, reports of positive profit trends were 22 points better!  Not seasonally adjusted, 12 percent reported profits higher (down 2 points), but 53 percent reported profits falling (up 3 points).  Getting cheap loans or mark-downs on the purchase price of equipment is not sufficient to stimulate much spending if the equipment isn’t needed to serve customers (poor sales is the top vote recipient as the single most important business problem with 27 percent of the votes).  Attempts to stimulate capital spending with tax credits will not provide a noticeable boost to spending (just as tax credits for “job creation” will not induce firms to hire employees they wouldn’t have hired anyway).

The construction industry remains soft and a drag on the economy.  Only 2 percent increased inventories while 34 percent reported reductions over the past few months and only 6 percent plan increases in the fourth quarter compared to 16 percent that plan inventory reductions (not seasonally adjusted).  Twenty-nine percent did report cutting average selling prices and only 16 percent reported price hikes.  Weak sales got the most votes as the number one problem facing construction firm owners, taxes came in second and insurance and labor quality tied for third in the voting.  No issues with finding qualified workers.  Even with the price hikes, 53 percent of the owners reported lower earnings quarter to quarter compared to 12 percent reporting gains.

INVENTORIES: 

Small business owners continued to liquidate inventories, a negative for fourth quarter GDP numbers.  A net negative 21 percent of owners reported gains in inventory stocks (more firms cut stocks than added to them, seasonally adjusted, 4 points worse than November), the 9^th negative double digit month in a row and the 19^th negative month in a row.  Unadjusted, 7 percent reported gains and 29 percent reported inventory reductions.  In construction, 2 percent reported gains (down 1 point) and 32 percent reported reductions (up 11 points).  With starts falling to an annual rate of about 600,000 and fundamental demand (and deletions) absorbing about 1.5 million units normally, surplus housing should start to disappear in the first quarter except in Florida and California and Phoenix and Las Vegas where construction activity was abnormally high over the past several years.

For all firms, a net negative 7 percent (down 3 points) reported stocks too low (seasonally adjusted).  The net percent of all owners (seasonally adjusted) reporting higher sales in the past three months lost 4 points, falling to a net negative 29 percent, the worst reading in survey history.   Unadjusted, 15 percent of all owners reported higher sales (up 1 point) and 46 percent reported lower sales (up 9 points).  Among retailers, 14 percent reported higher sales quarter over quarter, while 55 percent reported declines in sales volumes.  The magnitude of the declines is not recorded, but the pervasiveness of the declines indicates widespread weakness that squares with the weakness in job creation plans in all 9 Census regions.

The net percent of owners expecting gains in real sales volumes fell to a net negative 18 points (down 4 points) seasonally adjusted.  Plans to add to inventories (on purpose) gained 2 points, rising to net negative 4 percent of all firms, seasonally adjusted (improving from negative 6 percent).  Few new orders will appear until customers show up to absorb an inventory that is lean in absolute terms but large relative to depressed sales levels.  Seasonally unadjusted, 12 percent plan to add to stocks (up 3 points) while 17 percent will reduce stocks (down 3 points).  New orders will remain depressed until stocks look lean relative to expected sales, which are quite depressed in the current period.

INFLATION: 

Price pressures vanished in November and disinflation appeared in December.  The net percent of owners reporting higher average selling prices dropped 6 points to a net negative 6 percent in December.  This represents a 38 percentage point decline in the percent of owners raising average selling prices since July, an unprecedented decline in six months.    Unadjusted, 17 percent reported raising average selling prices, down 4 points, and 24 percent reported lower selling prices, up 1 point from November.  The percent of owners citing inflation as their number one problem fell 2 points to 7 percent.  The average percent of owners citing inflation as problem # 1 since the monthly surveys were started in 1986 is 3 percent.  In July, 20 percent cited inflation as their single most important problem, so inflation is fading as a concern for owners, replaced by worries over declining sales.  Only in the retail and wholesale trades did more firms report raising average selling prices than cutting them.  In all other industries (and for all firms), more firms reported cutting prices that raising them. 

Plans to raise prices fell 8 points to a net seasonally adjusted 3 percent of owners, 35 points below the July reading.  This is good news for the Fed.  In construction, a net 7 percent plan price hikes, in manufacturing  a net 12 percent, and among retailers, a net 13 percent plan hikes – this in a very weak economy.  It is unlikely that these planned hikes will stick, although as is always the case, the entire economy is not in recession, some sectors and regions are not as distressed as others and some firms will be able to raise prices.

PROFITS AND WAGES: 

The net percent of owners reporting earnings gains deteriorated further in December.  Seasonally adjusted, those reporting declining earnings trends outnumbered those with gains by 42 percentage points, the worst showing in 35 years of survey history.  Pricing power has vanished and reports of sales declines are at record high levels.  Profits can’t improve in this environment.  Wage pressures are falling, providing some positive support to the bottom line.  Seven percent of the owners reported reducing worker compensation, double earlier months and a survey record high.  And, only 12 percent reported raising worker compensation, a survey record low.  Labor markets are soft enough and inflation low enough to keep the lid on nominal compensation.

Of the owners reporting higher earnings (12 percent, down 2 points), 43 percent cited stronger sales (down 21 points) as the cause, and 7 percent each credited lower materials costs and higher selling prices. For those reporting lower earnings compared to the previous three months (53 percent, up 3 points), 51 percent cited weaker sales (down 3 points), 4 percent blamed higher compensation costs, 17 percent cited higher materials costs (including energy), 2 percent cited insurance costs and 8 percent blamed lower selling prices.

CREDIT MARKETS: 

As the economy weakens, loan demand remains weak.  Only 33 percent reported regular borrowing, close to the record low of 31 percent.  As noted above, plans to add to inventories and plans for capital outlays have declined to historically low levels since September of 2007, reducing the demand for loans.  Because of the slowdown in the economy, the credit worthiness of many potential borrowers has also deteriorated over the last year, leading to more difficult terms and higher loan rejection rates (even with no change in lending standards).

Thirty-two percent reported all their borrowing needs met (up 1 point) compared to 6 percent who reported problems obtaining desired financing (down 1 point).   The net percent reporting all borrowing needs satisfied improved 2 points to 26 percent (the low for the series of 22 percent was reached in 1993, the question was first asked in 1993).  

The net percent of owners reporting loans harder to get rose 1 point to 12 percent of all firms, matching the expansion high reached in 1991.  No “credit crunch” has appeared to date beyond the normal cyclical tightening of credit.  In 1983, 2 percent reported credit harder to get, and this rose over the expansion to 12 percent at the end in 1991.  In 1980, 28 percent reported credit harder to get, indicating that owners will report difficult credit conditions when they occur.

The percent of owners citing financing and interest rates as their single most important problem was unchanged at 3 percent.  Few owners are concerned about credit nor have they expressed concern during the entire period of the so called “credit crunch”.  For comparison, in 1982, 37 percent said financing and interest rates were their #1 business problem. 

The percent of owners reporting lower interest rates on their most recent loan exceed those reporting higher rates by 8 percentage points as the Fed rate cuts work their way through the variable rate loans.  Whether more loans will be made based on these lower rates is problematic as lenders don’t want to lock in low fixed loan rates knowing that the Fed will have to raise rates and the cost of deposits again in the near future.  But overall, it appears that Main Street credit conditions have not worsened in proportion to the Wall Street experience and interest rates are falling, especially for those with variable rate loans.  This means borrowers have more to spend, although dollar for dollar, savers have less.

The net percent of owners expecting credit conditions to ease in the coming months was a seasonally adjusted net negative 15 percent (more owners expect that it will be “harder” to arrange financing), 2 points worse than November. More owners expect credit to tighten on Main Street than get easier in spite of the Fed’s expansionary policies.   Even though owners do not report deteriorating borrowing conditions or complain about credit availability (compared to what is usually recorded at the end of an expansion), they keep expecting it to get worse, whatever that means.

OVERVIEW:

The December NFIB survey did not provide much fuel for optimism about growth prospects in the near term.  The net percent of owners planning to create new jobs is a negative 6 percent, rivaling readings in the 1974-5 and 1980-82 periods.  The percent with unfilled openings is the lowest since 1992 (but still better than in 1990-91 and 1980-82 periods) and unchanged for 3 months, a good sign.  Reports of declining sales are the largest in survey history (magnitudes of the declines are unknown).  Planned capital expenditures are at record low levels – projects are being postponed to conserve cash! 

Pricing power has vanished, with more firms reporting price reductions than price increases, the start of “disinflation” of sorts.  Interestingly, only in the retail and wholesale trades did more owners report price increases than decreases in average selling prices, but only by small margins (25 percent of the firms in the sample).  Consumers failed to “save” the fourth quarter as “Black Friday” turned to various shades of grey, then pink, then red as consumers tried to “save” themselves by spending less and saving more. 

The National Bureau of Economic Research, the official “historians” of the business cycle, report that the economy has been in recession for a year, peaking in December, 2007.  Since then, the economy has slogged its way downhill.  The first quarter posted growth of 0.9% followed by 2.8% in the second, then -0.5% in the third quarter this year.  This was driven primarily by export growth (and a weak dollar and falling oil prices). No “rule of thumb” recession (two quarters of negative growth back to back) yet, but with fourth quarter growth expected to be about negative 5 percent, we’ll satisfy the rule.

The recession is trying to sort out the winners from the losers, a necessary process.  Government policy is, in simple terms, interfering by providing “humanitarian relief” to struggling firms and consumers to blunt the impact of the adjustment on its citizens.  At 7 percent unemployment, 93 out of every hundred people that want a job have one (better than the best of times in many industrialized countries).  Unemployment benefits and bailouts that prevent market-enforced job loss share the burden of those caught up in the process with those who are less harmed.  This is typically the way the story plays out and there will be long term implications as always.  At the end of this chapter of our economic history, the reach of government into the private sector will be large indeed and how well the economy does going forward will depend in part on how this is managed.  As always, we will be hampered in this by the political imperative of elections, now less than two years away.

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NFIB began surveys of its membership in October, 1973.  Surveys were conducted in the first month of each quarter through 1985 when monthly surveys were instituted.  The first month in each quarter is based on between 1,200 and 2,000 respondents, while the following two monthly surveys contain between 400 and 700 respondents.  The term “net percent” means that the percent of owners giving an unfavorable response has been subtracted from the percent giving a favorable response.  If, for example, 20 percent reported that they were going to increase the number of workers at the firm and 5 percent reported an intention to reduce the number of workers, the “net percent” would be 20 percent – 5 percent  or a net 15 percent planning to expand employment.  These figures are seasonally adjusted unless noted.  The graphs show quarterly data (first survey month in each quarter), updated when available by subsequent monthly surveys.

Published with permission from NFIB.