NFIB Small Business Economic Trends - December 2017

 

Embargoed Tuesday, January 9 at 6 a.m.

 

 (Based on 495 respondents to the December survey of a random sample of

NFIB’s member firms, surveyed through 12/30/17)

 

 

Overview

 

The Index of Small Business Optimism lost 2.6 points in December, falling to 104.9, still one of the strongest readings in the 45 year history of the NFIB surveys (108.0 in July 1983, 79.7 in April, 1980, 107.5 in November).  Three of the 10 Index components posted a gain, four declined, and three were unchanged.  The decline left the Index historically strong and maintained a string of exceptional readings that started the day after the election results were announced.  Following the election announcement, the Index rose from 95 (a below average reading) for October and pre-election November to 102 in the November weeks after the election and then to 105 in January. 

 

Reports of higher selling prices faded a bit, lending no support to the Fed goal of higher inflation (a dubious goal).  Interest in borrowing remained subdued and complaints about credit availability stayed at historically low levels.  Job creation was subdued, but hiring plans soared, primarily in construction, manufacturing and professional services.  Finding qualified workers was the second most important problem facing owners, only taxes polled higher.  Reports of compensation gains remained historically strong as the intensity of competition for “qualified” workers intensifies. 

 

Small Business Optimism and Ten Components

 

                                                                   December    Change        Share of

                                                                                                               Change 

CREATE NEW JOBS (net)

 

 

     20%

       -4

      13%

MAKE CAPITAL OUTLAYS

 

 

     27%

      +1

       -3%

INCREASE INVENTORIES (net)

 

 

    -1%

       -8

      27%

JOB OPENINGS HARD TO FILL

 

 

     31%

      +1

       -3%

INVENTORIES TOO LOW (net)

 

 

      -2%

        0

        0%

GOOD TIME TO EXPAND

 

 

     27%

        0

        0%

EXPECT BETTER BUSINESS CONDITIONS IN 6 MONTHS(net)

 

 

     37%

     -11

      37%

EXPECT HIGHER REAL SALES (net)

 

 

     28%

       -6

      30%

EXPECT EASIER CREDIT CONDITIONS (net)

 

 

      -4%

 

        0

        0%

EARNINGS TRENDS POSITIVE (net)

 

 

    -15%

       -3

      10%

 

 

 

 

 

 

TOTAL CHANGE

INDEX OF SMALL BUSINESS OPTIMISM  (1986 = 100)

 

 

 

  104.9

  

      -30

     -2.6

      100%

 

[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 <0.5% or not a meaningful calculation.  Index is based to the average value in 1986, components are not. 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.  For some questions, there is no “unfavorable” response category]

 

 

 

LABOR MARKETS

 

 

Job creation was slow in the small business sector as business owners reported a seasonally adjusted average employment change per firm of 0.01 workers.  Clearly, a lack of “qualified” workers is impeding the growth in employment. Thirteen percent (unchanged) reported increasing employment an average of 2.0 workers per firm and 10 percent (unchanged) reported reducing employment an average of 4.1 workers per firm (seasonally adjusted). 

Fifty-nine percent reported hiring or trying to hire (up 7 points), but 54 percent (92 percent of those hiring or trying to hire) reported few or no qualified applicants for the positions they were trying to fill, a record high. Nineteen percent of owners cited the difficulty of finding qualified workers as their Single Most Important Business Problem (up 1 point), second only to taxes.  This is the top ranked problem for those in construction (30 percent) and manufacturing (27 percent), getting more votes than taxes and the cost of regulations.  Higher readings occurred in the expansion leading up to 2000 when 63.4 percent of the adult population had a job compared to 60.1 percent today.

 

Thirty-one percent of all owners reported job openings they could not fill in the current period, up 1 point from November.  Twelve percent reported using temporary workers, up 1 point.  Reports of job openings were most frequent in construction (51 percent, up 10 points), manufacturing (37 percent) and retail (21 percent, down 10 points after holidays).

A seasonally adjusted net 20 percent plan to create new jobs, down 4 points from a record high reading and the second highest reading since October 1999.  Not seasonally adjusted, 21 percent plan to increase employment at their firm (down 1 point), and 6 percent plan reductions (up 1 point).  Hiring plans were strongest in construction (25 percent net of planned reductions), manufacturing (net 26 percent) and professional services (net 29 percent).  Historically an exceptionally strong outlook for job creation.  The availability of qualified workers will undoubtedly moderate actual job creation.

 

Overall, labor demand remains historically very strong, with historically high job openings and plans to create new jobs (the question asked is “do you plan to increase or decrease the total number of people working for you?”).  The major concern will be the response of labor force participation (will workers be available?) and job qualification issues (will construction and manufacturing firms be able to find the qualified workers to fill their open positions?).  Trying to solve this problem, 23 percent plan to raise worker compensation, the highest reading since 2000, and 27 percent reported raising compensation last quarter (see below). 

 

CAPITAL SPENDING

 

Sixty-one percent reported capital outlays, up 2 points.  This anticipates a substantial increase in capital spending.  Of those making expenditures, 43 percent reported spending on new equipment (up 3 points), 23 percent acquired vehicles (down 6 points), and 16 percent improved or expanded facilities (unchanged).  Six percent acquired new buildings or land for expansion (up 1 point) and 15 percent spent money for new fixtures and furniture (up 2 points). 

 

 

Twenty-seven percent plan capital outlays in the next few months, up 1 point from November.  Plans were most frequent in construction (32 percent), agriculture (31 percent), professional services (38 percent) and manufacturing (38 percent).  Improvements in productivity depend crucially on investment spending in the labor intensive small business sector.  The reduction in tax rates will improve the value of existing capital as well as new capital investments (until competition eliminates any “excess” profits through reduced prices) and cash flows will improve.   Improved earnings from lower taxes (and regulatory taxes) and growth will enlarge the pool of earnings available to support capital spending

 

 

 

SALES

 

The net percent of all owners (seasonally adjusted) reporting higher nominal sales in the past three months compared to the prior three months was a net 9 percent, a 14 point improvement from November.  Tentative customers in November became aggressive spenders across the board in December, closing out the year with very strong reports of sales gains, the best levels since 2006.

 

 

After a strong surge in November,  the net percent of owners expecting higher real sales volumes fell 6 points, falling to a net 28 percent of owners, still one of the best readings since 2007. Very positive sales expectations are undoubtedly behind the continued strength in hiring plans. 

 

 

INVENTORIES:

 

The net percent of owners reporting inventory increases was unchanged at a net negative 2 percent (seasonally adjusted).  Strong sales (see above) resulted in a drawdown in inventories, setting the stage for additional inventory investment in 2019.

 

The net percent of owners viewing current inventory stocks as “too low” was unchanged at a net negative 2 percent, a positive view of current stocks which could produce additional orders for new inventory.

 

 

The net percent of owners planning to add to inventory fell 8 points to a net negative 1 percent, reversing surprisingly strong November investment plans.  Inventory investment was a major contributor to the growth in GDP in the second half of the year. This will likely reverse in the January survey.

 

 

INFLATION: 

 

The net percent of owners raising average selling prices fell 2 points to a net 8 percent seasonally adjusted, ending a steady but modest uptrend in the frequency of reported price increases.  Clearly, inflation is not “breaking out” across the country as the Federal Reserve hoped.  Unadjusted, eleven percent of owners reported reducing their average selling prices in the past three months (up 1 point), and 15 percent reported price increases (down 2 points). 

 

 

 

Seasonally adjusted, a net 23 percent plan price hikes (up 1 point), although far fewer will report actually doing so in the following months.  But there is a strong dynamic in prices adjustments on Main Street that is typical of a less regulated market.   

 

The Federal Reserve has operated with a view that rising wages (or labor costs) will always produce inflation.  Although there is a positive correlation between labor cost increases and price increases, it is not perfect (see below), indicating that there are other intervening factors that shape just how quickly labor costs are passed on to customers in higher prices.  The “surge” in reports of higher wages and bonuses for workers is good news to the Fed (and workers), but is not likely to impact inflation because most of this will be paid for out of higher profits resulting from tax cuts.  Announcements of increased wage rates (such as establishing a $15/hour wage for the firm) suggest more than just casual optimism about growth in the economy as these must be paid every year, not just one time as is the case for bonuses.

 

 

 

 

COMPENSATION AND EARNINGS: 

 

Reports of higher worker compensation were unchanged at a net 27 percent, historically very strong all last year.  The Federal Reserve is hoping this will result in inflation as owners pass these costs on in the form of higher selling prices, but to date, their wish has not been granted to any significant degree.  Tight labor markets are historically associated with high percentages of owners raising worker compensation.

 

 

 

Owners complain at record rates of labor quality issues, with 92 percent of those hiring or trying to hire reporting few or no qualified applicants for their open positions.  Nineteen percent selected “finding qualified labor” as their top business problem, far more than cite weak sales or the cost of regulations as their top challenge.  Plans to raise compensation jumped 6 points in frequency to a net 23 percent in response to tighter labor markets.  Small firms are unlikely to respond to lower tax rates by raising compensation as their large peers have done because the consequences of the tax code on their earnings are less clear.  Pass-through regulations are complex, making it more difficult to determine tax status for 2018.

 

 

 

The frequency of reports of positive profit trends fell 2 points to a net negative 15 percent reporting quarter on quarter profit improvements, a solid reading historically but not exceptional.  Firms that survived the Great Recession and 8 years of sub-par growth have learned how to make money in hard times and benefit at the bottom line when the economy suddenly picks up speed (3 percent or better growth).

 

 

CREDIT MARKETS:  

 

Three percent of owners reported that all their borrowing needs were not satisfied, down 1 point and historically low. Thirty-two percent reported all credit needs met (unchanged) and 52 percent said they were not interested in a loan, up 4 points.  Only 1 percent reported that financing was their top business problem compared to 21 percent citing taxes, 16 percent citing regulations and red tape, and 19 percent the availability of qualified labor.  Weak sales garnered only 8 percent of the vote after a solid holiday. Three percent reported loans “harder to get’, down 1 point at historic lows. In short, credit availability and cost is not an issue and hasn’t been for many years.

 

The important role of market interest rates is to allocate financial capital to its most valued uses.  Historically, reports of changes in interest rates paid on loans suggest that markets performed this role.  However, starting with 2008-9, the volatility in interest rates flat-lined as the Fed took rates to the “0 bound”.  Price rationing became impossible, so the adjustment shifted to credit rationing, turning down loan applicants rather than pricing risk into the interest rate offered/charged.  As the Fed lifts off the 0 bound, evidence that market interest rates may be resuming their historical function appears in owner experiences with rate seeking in the market as reports of higher rates have also risen from the “zero” level.

 

Thirty-four percent of all owners reported borrowing on a regular basis (up 4 points). The average rate paid on short maturity loans was up 50 basis points at 6.1 percent after the Federal Reserve raised rates.  Overall, loan demand remains steady, even with cheap money.  Small businesses have been restructuring over the past ten years, profit trends have been historically good, and owners are in a good position to borrow once they have a good reason to do so.

 

THE LARGER PERSPECTIVE:

 

The “tax bill” was passed and signed by the President on December 22.  Strangely, consumer sentiment (University of Michigan) declined a few points (mostly among lower income consumers) and the net percent characterizing government as “good” fell 6 points, likely due in large part to the constant negative drum beat of the Democrats as the bill neared passage. Compared to the Reagan cuts, this bill was more heavily weighted toward “business” because marginal tax rates for individuals were already quite low compared to the Reagan era and, more significantly, the current bill recognized the importance of tax cuts for “pass through” businesses.

 

Opponents of the tax bill are critical and offer up hypothetical analyses to show that the bill is “regressive”, assuming little or no economic growth (which drives tax revenues) and reductions in welfare programs (which do badly need some revisions), and no employment benefits (more jobs and higher wages) to name a few of the assumptions made which guarantee a negative assessment.  They predicted the economy would collapse with a  Trump victory, and can’t believe how strong the economy has become.  These politically motivated assessments give the economics profession a bad name and perpetuate the hostility that misinformation produces.  The 3 percent plus growth expected in the first quarter will produce 12 months of growth in excess of 3 percent, something critics denied would happen.  Former president Obama said “Congratualtions Obama”, trying to take credit for the growth that suddenly bloomed as soon as the election results were known, ignoring the 8 years of anti-growth policies and trillion dollar deficits that characterized his 8 years in office. 

 

The NFIB indicators clearly anticipate further upticks in economic growth, perhaps pushing up toward 4 percent for the fourth quarter.  This is a dramatically different picture than owners presented during the 2009-16 recovery under President Obama.  The change in the management team dramatically improved expectations, and that began to translate into real spending and hiring.  Owners did not know exactly what the tax bill would look like, but believed that whatever it looked like, it would be a significant improvement over what was currently in force.  That was enough to “bet on”. 

 

As proof, the stock market was up $7 trillion last year, over 2 million new jobs were created, capital spending lifted off (good for productivity), and housing is running at full tilt.  All of this started as soon as the old management team was tossed out (apparently many are still operating in the government however).  This is a huge disappointment of course to all the liberals, economists included, who predicted that the economy would collapse if Mr. Trump were elected.  Small business owners had it right, their optimism (and subsequent spending and hiring) rose the day after the election results were announced.  By the second quarter, 3 percent growth had been restored as the small business sector (and others) shook of the shackles of pessimism as the new government began eliminating the impediments to growth put in place by the prior administration.  The private sector can make good things happen once the heavy hand of government management of the economy is lifted. 

 

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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 900 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.