A Hint of Small-Business Optimism

 | Dec 14, 2011 | 2:00 PM EST
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The National Federation of Independent Businesses released its Small Business Economic Trends report earlier this week. This optimism index, as it is sometimes called, is showing more optimism, although it is still at historically rather low levels. But the improving direction is important. It increased 1.8 points to 92.0 and the improvement, while small, was widespread among the components of the report and, importantly, the forward-looking components posted solid gains.

The improvement is welcome and I personally like this particular measure because small businesses are a good barometer of the U.S. economy. Unlike companies in the S&P 500, which derive around 44% of their sales from abroad, small companies are tied to the health of the economy here at home, though some are exporters or suppliers to exporters  Importantly, small business owners are arguably much more connected to their end customers than CEOs of large companies might be. And changes in sentiment of small business owners can give us a perhaps more accurate and timely read on where the domestic economy is headed.

Also, since most small businesses depend on bank financing rather than bond issuance, what they tell us about credit market conditions gives us an idea of banks' willingness to lend. And since companies with fewer than 20 employees comprise 20% of U.S. employment in 2007, but accounted for 33% of job losses during the recession according to this report, what they tell us about hiring prospects is also important.

The group observed that "the economy is slowly righting itself" and the adjustment to the asset boom and bust "seems to be about over."  But sales are still sluggish enough that companies are still reluctant to hire as there may be little for a new employee to do. A net 4% expect real sales to be higher, marking an 8 point increase from the prior month. It is now in positive territory, but still lower than when we started the year.  

Still, a net 7% of firms plan to hire in the next few months. The hiring intentions metric is the strongest reading in 38 months, but in expansions it typically is in double-digit terrain. The reading on actual new hires is now in positive territory for the first time since the recession began. They are also planning to give, or have given, their employees raises to the greatest extent since 2008.

The election would "clear the air" for more improvement in business activity in the small business sector, the report said. (The report was silent on whose polices would be best, as the general tone of the group's commentary is that simply getting an answer to that question of politics is more important than what the answer actually is.)

It's those big-picture issues that seem more of a concern than the specifics of the group's members' businesses. For example, a net -12% expect the economy to improve. In other words, more respondents expect that macro conditions will worsen than get better, yet a net positive 8% said now is a good time to expand their businesses. The latter metric is the best showing in 38 months and both of these metrics showed small improvements from the month before. Additionally, a net positive 24% plan to make capital outlays, which is improvement from last month and the highest in 40 months.

Poor sales are still the primary concern of small businesses at 25%. Only 3% report credit as their No. 1 problem and most aren't interested in borrowing.  What's noteworthy is the average interest rate these companies are paying on short-term loans of less than 12 months. It's 6.3%, basically unchanged since 2008. Even though the Fed may have taken short-term rates to near zero, that's not at all what banks are charging their customers and it is one reason why most respondents said they aren't interested in taking out a new loan.  This is an excellent example of how and why Fed policies have had such little effect on jump-starting the economy.

The economy isn't growing as fast as it could be or used to, but the feeling by those companies directly and intimately interacting with their customers shows that it is improving. While Europe presents some obvious challenges, these issues are, of course, widely known by respondents to the survey. And they are still more optimistic about their sales prospects than they were a few months back. That improvement is welcome news indeed, even if the levels are still on the low side, historically speaking.

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