NFIB Small Business Economic Trends - December 2017

 

Embargoed Tuesday, February 13 at 6 a.m.

 

 (Based on 1658 respondents to the January survey of a random sample of

NFIB’s member firms, surveyed through 1/29/18)

 

 

Overview

 

The Index of Small Business Optimism gained 2.0 points in January, rising to 106.9, again one of the strongest readings in the 45-year history of the NFIB surveys. The highest reading of 108.0 was reached in July 1983and the lowest reading of 79.7 occurred in April 1980.  Six of the 10 Index components posted a gain, two declined, and two were unchanged.  The gain left the Index historically strong and maintained a string of exceptional readings that started the day after the 2016 election results were announced.  A year after the election-induced surge in Optimism, small business owners remain confident about the future.

 

The net percent of owners reporting higher selling prices continued to inch upward, reaching the highest level since 2014.  Job creation posted a solid gain and hiring plans remained strong even as reports of labor quality as a top business problem reached record levels. Reports of compensation rose to the highest level seen since 2000, the peak of the last expansion.  Overall, small business owners are ready to support three percent plus growth, have accumulated capital and have access to bank loans to finance their growth.  Reports of positive profit trends accounted for half of the Index gain, a welcome development.  What is needed is continued economic policy that is supportive of growth and entrepreneurship and lessens the burden of government on the private sector, the engine of growth.

 

Small Business Optimism and Ten Components

                                                                                                                 Share of

                                                                      January      Change          Change 

CREATE NEW JOBS (net)

 

 

   20%

        0

         0%

MAKE CAPITAL OUTLAYS

 

 

   29%

      +2

         7%

INCREASE INVENTORIES (net)

 

 

     3%

      +4

       18%

JOB OPENINGS HARD TO FILL

 

 

   34%

      +3

       13%

INVENTORIES TOO LOW (net)

 

 

    -5%

       -3

      -13%

GOOD TIME TO EXPAND

 

 

   32%

      +5

       22%

EXPECT BETTER BUSINESS CONDITIONS IN 6 MONTHS(net)

 

 

   41%

      +4

       18%

EXPECT HIGHER REAL SALES (net)

 

 

   25%

       -3

       -13%

EXPECT EASIER CREDIT CONDITIONS (net)

 

 

    -4%

 

        0

          0%

EARNINGS TRENDS POSITIVE (net)

 

 

    -4%

    +11

        48%

 

 

 

 

 

 

TOTAL CHANGE

INDEX OF SMALL BUSINESS OPTIMISM  (1986 = 100)

 

 

 

  106.9

  

     +23

      2.0

      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]

 

The percent of owners viewing the current period as a “good time for small business to expand substantially” hit the highest level in the history of the NFIB survey (started in 1973).  For 8 years, abysmal growth and misdirected economic policies produced a dim view about the future, one not supportive of investment and expansion.  The election changed all that, and optimism surged the day after the results were known.  Since then, economic growth has improved 50 percent and promises to remain strong, bolstered by further improvements in economic policy.  A positive view of the future is a critical component driving business investment and improving worker productivity.  Small business owners have never been more positive about moving ahead.

 

 

LABOR MARKETS

 

Job creation was solid in the small-business sector as owners reported a seasonally adjusted average employment change per firm of 0.23 workers, a strong showing.  The lack of “qualified” workers is impeding the growth in employment. Thirteen percent (unchanged) reported increasing employment an average of 2.9 workers per firm and 9 percent (down 1 point) reported reducing employment an average of 3.4 workers per firm (seasonally adjusted). 

Fifty-five percent reported hiring or trying to hire (down 4 points), but 49 percent (89 percent of those hiring or trying to hire) reported few or no qualified applicants for the positions they were trying to fill.  Twenty-two percent of owners cited the difficulty of finding qualified workers as their Single Most Important Business Problem (up 3 points), exceeding the percentage citing taxes or the cost of regulation as their top business problem.  This is the top ranked problem for those in construction (36 percent) and manufacturing (25 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.  However, retirement is reducing the numbers of skilled workers willing to fill positions in these industries.

 

 

Thirty-four percent of all owners reported job openings they could not fill in the current period, up 3 points from December. Twelve percent reported using temporary workers, unchanged.  Reports of job openings were most frequent in construction (47 percent), manufacturing (39 percent), transportation and communication (52 percent) and non-professional services (36 percent).  Labor shortages are serious and slowing the growth in output and employment.

 

 

A seasonally adjusted net 20 percent plan to create new jobs, unchanged from December and at record high levels.  Not seasonally adjusted, 25 percent plan to increase employment at their firm (up 4 points), and 3 percent plan reductions (down 3 points).  Hiring plans were strongest in construction (net 33 percent), manufacturing (net 26 percent), transportation and communication (net 30 percent) and professional services (net 26 percent).  Historically an exceptionally strong outlook for job creation.  The availability of qualified workers will undoubtedly moderate actual job growth.

 

 

Labor markets have become very tight, for both skilled and unskilled workers. Trying to solve this problem, a net 24 percent plan to raise worker compensation, the highest reading since December 1989, and 31 percent reported raising compensation to attract or retain employees (highest since December, 2000, the peak of the last expansion).  Only an increase in the labor force and an increase in the participation rate can provide relief from the impact of labor shortages.

 

 

 

CAPITAL SPENDING

 

Sixty-one percent reported capital outlays, unchanged from December and the second highest reading in this recovery to date.  This anticipates a substantial increase in capital spending.  Of those making expenditures, 44 percent reported spending on new equipment (up 1 point), 28 percent acquired vehicles (up 5 points), and 16 percent improved or expanded facilities (unchanged).  Six percent acquired new buildings or land for expansion (unchanged) and 13 percent spent money for new fixtures and furniture (down 2 points). 

 

 

 

Twenty-nine percent plan capital outlays in the next few months, up 2 points from December.  Plans were most frequent in construction (32 percent), agriculture (31 percent), professional services (37 percent), transportation and communication (48 percent), non-professional services (31 percent) and manufacturing (36 percent).  Improvements in productivity depend crucially on investment spending in the labor intensive small-business sector.  Improved earnings trends and lower taxes increase the pool of capital available for firms to invest in their businesses.  Many of these investments do not involve “high” or new technology, just improvements in standard equipment and processes.

 

 

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 5 percent, a 4 point decline following on a 14 point improvement in December.  Consumers became aggressive spenders across the board in December, and continued to follow through in January.

 

 

The net percent of owners expecting higher real sales volumes fell 3 points, falling to a net 25 percent of owners, still one of the best readings since 2007.  Positive expectations surged over 30 points in December, 2017, after the election and have remained historically high since then, reaching 35 percent in November.  Very positive sales expectations are undoubtedly behind the continued strength in hiring plans. 

 

INVENTORIES:

 

The net percent of owners reporting inventory increases rose 6 percentage points to a net 4 percent (seasonally adjusted).  Strong sales in the fourth quarter induced owners to increase orders and add to stocks.  Inventory rebuilding will continue into the first quarter, adding to GDP growth on top of actual consumer purchases.

 

 

The net percent of owners viewing current inventory stocks as “too low” was a net negative 5 percent, 3 points lower than December.  Apparently the buildup of inventories left stocks a bit larger than owners wanted, based on expected sales volumes (which faded a bit in January)

 

 

However, the net percent of owners planning to add to inventory rose 4 points from December to a net 3 percent, a solid number.  Plans averaged 4 percent in the last 6 months of 2017 as firms geared up for a solid holiday season.  Inventory investment was a major contributor to the growth in GDP in the second half of last year and it appears that this momentum will continue into the first quarter as recent news about the economy may have comforted owners about their decisions to build stocks in the fourth quarter.  

 

 

INFLATION: 

 

The net percent of owners raising average selling prices rose 3 points to a net 11 percent seasonally adjusted, the highest reading since July, 2014.  Clearly, inflation is not “breaking out” across the country as the Federal Reserve hoped.  Unadjusted, 9 percent of owners reported reducing their average selling prices in the past three months (down 2 points), and 19 percent reported price increases (up 4 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. There is a strong dynamic in price adjustments on Main Street that is typical of a less regulated market.   

 

Overall, there is not much pressure on inflation coming from Main Street which historically played a major role in the inflation picture.  In the late 1970s, as many as 70 percent of small business owners reported raising their average selling prices, contributing to inflation rates over 15 percent.  The Federal Reserve has kept interest rates low hoping to simulate spending (directly with low interest rates on loans and indirectly by inflating assets prices to increase wealth) and thus inflation.  Spending did not respond to the low rates, primarily because even cheap money has to be invested in a way that provides a good return and prospects for government policies and economic growth were not positive from 2009 to 2016.  Since the election, spending has increased substantially, among consumers and firms investing in their growth. But cost pressures (including record high reports of higher compensation) have not produced significant price increases, and profit trends have improved. 

 

 

 

 

 

 

COMPENSATION AND EARNINGS: 

 

Reports of higher worker compensation rose 4 percentatge points to a net 31 percent, the highest reading since 2000 and among the highest in survey history.  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 89 percent of those hiring or trying to hire reporting few or no qualified applicants for their open positions.  Twenty-two percent (up 3 points) selected “finding qualified labor” as their top business problem, more than cited taxes, weak sales or the cost of regulations as their top challenge.  The highest reading since 2000, the peak of the last expansion.

 

Plans to raise compensation rose 1 point in frequency to a net 24 percent in response to tighter labor markets, the highest reading since 1989.  Small firms are raising compensation to attract and keep the employees they need.  Reports of higher compensation are less like to be consequences of the tax code because pass-through tax rate changes are complex, making it more difficult to determine tax status for 2018 and beyond.  It is simply the need to attract and keep workers that is driving compensation.

 

 

 

The frequency of reports of positive profit trends improved a huge 11 points to a net negative 4 percent reporting quarter on quarter profit improvements, the best reading since March of 1988, a long “dry spell”.  Firms that survived the Great Recession and eight 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.  Costs will rise as growth produces tight spots in sub-markets that cause input prices to start rising,

 

CREDIT MARKETS:  

 

Three percent of owners reported that all their borrowing needs were not satisfied, unchanged and historically low. Thirty-one percent reported all credit needs met (down 1 point) and 52 percent said they were not interested in a loan, unchanged.  Only 2 percent reported that financing was their top business problem compared to 19 percent citing taxes, 16 percent citing regulations and red tape, and 22 percent the availability of qualified labor.  Weak sales garnered only 9 percent of the vote after a solid holiday. Three percent reported loans “harder to get’, unchanged and 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 Federal Reserve 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 Federal Reserve 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-one percent of all owners reported borrowing on a regular basis (down 3 points).  The average rate paid on short maturity loans was down 20 basis points at 5.9 percent. If the Fed raises the anticipated 3 times this year, variable rate loan costs will respond immediately, although longer term rates are not likely to reflect the full hike.  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, leaving owners in a good position to borrow once they need financing beyond the resources provided by their firm operations.

 

 

THE LARGER PERSPECTIVE:

 

In the minutes of the last Federal Reserve, discussion of inflation mirrored much of the recent public discussion by Chair Yellen, who acknowledged the difficulties the committee has in understanding current inflation dynamics and why inflation continues to remain below target, despite very accommodative policies.  It is a worrisome that our central bank wants to create inflation and assumes that once it has “enough”, it can keep inflation from going higher (their forecast is that inflation will continue to rise and then stop at their target of 2 percent, no explanation of why it will stop).  There is no rigorous explanation of why 2 percent is the “right’ level for the economy.  If it is not, pursing policies that try to increase inflation could become even more damaging to the economy.  Meantime, the Fed will continue to raise rates.

 

The U.S. ranked second in the World Economic Forum (Davos)’s assessment of global competitiveness.  Strong points included inflation, venture capital, business sophistication, innovation, financial market development, labor market efficiency and higher education and training.  Not so good were ranks of 61st (out of 137 economies studied) on business costs of crime and violence, 57th on organized crime, 39th for internet use pentration and 95th on tax rate as a percent of profits (our new tax reform was not included).  The extensive size and performance of our small business sector plays a key role in supporting these rankings and now government policies are more focused on strengthening the competitiveness and performance of this sector by reducing regulatory restrictions that waste time and capital.

 

Immigration will now take center stage, with a lot of politics to blur the issues. In the main, most believe that immigration is an important component of the growth in population that supports economic growth in the U.S. (more people, more haircuts and beauty salon visits etc.).  But numbers are only part of the picture.  Are the immigrants capable of supporting themselves?  Are they young, or elderly and soon to need health care services and other support?  Do they have needed skills, are they educated, how well can they integrate with our society?  Immigration policy should be driven by the needs of our economy for various types of labor.  “Dreamers” have a head start as they have “grown up” in the U.S. and its education system and are young with years of potential labor force participation ahead of them.  Our policies will determine the number and the composition of the immigrant population.

 

A year after the election, owner optimism remains at historically high levels, undaunted by the barrage of attacks on the administration from the Democrats and liberals.  Not one Democrat member of Congress voted for the tax bill and they continue to resist Administration efforts to ease the burden of government (taxes and regulations) on the private sector, a proven policy during the past year and one that continues to be supportive of private sector growth on Main Street.

 

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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.