December 2018 Report: Small Business Optimism Index Small Business Optimism Virtually Unchanged as Demand for Workers Remains a Constraint

January 16, 2019

Twenty-three percent of owners cited the difficulty in finding qualified workers as their Single Most Important Business Problem.

The NFIB Small Business Optimism Index remained basically unchanged in December, drifting down 0.4 points to 104.4, according to the report released today. Unfilled jobs and the lack of qualified applicants continue to be a primary driver, with job openings setting a record high and job creation plans strengthening. Reports of higher worker compensation remained near record levels and inventory investment plans surged. Expected real sales growth and expected business conditions in the next six months, however, accounted for the modest decline in the Index.

“Optimism among small business owners continues to push record highs, but they need workers to generate more sales, provide services, and complete projects, said NFIB President and CEO Juanita D. Duggan. “Two of every three of these new jobs are historically created by the small business half of the economy, so it will be Main Street that will continue to drive economic growth.”

A recent historical perspective:

Actual hiring strengthened to the highest reading in six months, job openings are at a record high levels, and plans to create new jobs are down only three points from August’s record high.
The net percent of owners expecting better business conditions in six months and the percent viewing the current period as a good time to expand have both tapered off since the record high Index reading in August but still remain well above their historical averages.
Actual capital outlays are five percentage points higher than in August, although plans for outlays are eight points below the high for this expansion.
Plans to invest in inventories are only two points below August, the record high. Satisfaction with inventories is two points better.

Last week’s NFIB Jobs Report noted that job creation remained solid with a net addition of 0.25 workers per firm, up from 0.19 in November and the best reading since July. A seasonally-adjusted net 23 percent plan to create new jobs, up one point from November’s reading. Not seasonally adjusted, 23 percent plan to increase total employment at their firm (up one point), and five percent plan reductions (down two points).

A record 39 percent of small business owners reported job openings they could not fill in the current period. Sixty percent of owners reported hiring or trying to hire, but 90 percent of those reported few or no qualified applicants for the position. Twenty-three percent of owners cited the difficulty in finding qualified workers as their Single Most Important Business Problem.

“Recently, we’ve seen two themes promoted in the public discourse: first, the economy is going to overheat and cause inflation and second, the economy is slowing and the Federal Reserve should not raise interest rates,” said NFIB Chief Economist Bill Dunkelberg. “However, the NFIB surveys of the small business half of the economy have shown no signs of an inflation threat, and in real terms Main Street remains very strong, setting record levels of hiring along the way.”

The percent of business owners reporting that they increased employee compensation continued at 45-year record high levels. In December, a net 35 percent reported increasing compensation and a net 24 percent reported planned increases in the next few months.

The net percent of owners reporting inventory increases fell three points to a net three percent (seasonally adjusted), following November’s strong showing, the second-best since 2005.

A net four percent of all owners (seasonally adjusted) reported higher nominal sales in the past three months, down five points from very strong readings. The net percent reporting higher sales averaged two percent in 2017 but nine percent in 2018, with a peak value of 15 percent. The net percent of owners expecting higher real sales volumes fell one point to a net 23 percent of owners. Consumer spending has remained steady and small manufacturing and construction firms cannot find enough employees to fill their open positions, selling all they can produce without more workers.

Unchanged from last month, 61 percent of owners reported capital outlays. Of those making expenditures, 42 percent reported buying new equipment, 25 percent acquired vehicles, and 15 percent improved or expanded facilities. Six percent acquired new buildings or land for expansion and 15 percent spend money for new fixtures and furniture.

Thirty-two percent of owners reported all credit needs met (unchanged), and 50 percent said they were not interested in a loan, up three points. By comparison, only three percent reported financing was their top business problem (up one point), while 13 percent cited taxes (down six points), 14 percent citing regulations and red tape, and 23 percent the availability of qualified labor.

LABOR MARKETS

Job creation was solid in December with a net addition of 0.25 workers per firm (including those making no change in employment), up from 0.19 in November and the best reading since July. Fifteen percent (down 1 point) reported increasing employment an average of 3.0 workers per firm and 10 percent (down 1 point) reported reducing employment an average of 2.9 workers per firm (seasonally adjusted). Sixty percent reported hiring or trying to hire (unchanged), but 54 percent (90 percent of those hiring or trying to hire) reported few or no qualified applicants for the positions they were trying to fill (up 1 point). “Qualified” includes specific work-related skills but also covers poor appearance, attitude, social skills, and unreasonable wage expectations as well as poor work history. Twenty-three percent of owners cited the difficulty of finding qualified workers as their Single Most Important Business Problem, down 2 points from last month’s record high reading. Thirty-nine percent of all owners reported job openings they could not fill in the current period, up 5 points and a new record high. Labor markets are still exceptionally tight. Thirteen percent reported using temporary workers (down 1 point). In construction, 49 percent reported open positions and 42 percent in manufacturing (both not seasonally adjusted). A seasonally-adjusted net 23 percent plan to create new jobs, up 1 point from November’s reading. Thirty-three percent reported few qualified applicants for their open positions and 21 percent reported none! A net 35 percent reported higher compensation in December, and a net 24 percent planned increases in the next three months (down 1 point), predicting further gains in wages and benefits.

SALES AND INVENTORIES

A net 4 percent of all owners (seasonally adjusted) reported higher nominal sales in the past three months, down 5 points from November’s very strong reading. The net percent reporting higher sales averaged 2 percent in 2017 but 9 percent in 2018, with a peak value of 15 percent. Thirty percent or more of the owners in construction, transportation, and finance reported quarterly improvements in sales. The net percent of owners expecting higher real sales volumes fell 1 point to a net 23 percent, a solid reading.

The net percent of owners reporting inventory increases fell 3 points to a net 3 percent (seasonally adjusted), following November’s strong showing, the second-best since 2005. The net percent of owners viewing current inventory stocks as “too low” gained 4 points to a net negative 1 percent, a very “lean” reading, no surprise given the strength of consumer spending. In response, the net percent of owners planning to add to stocks rose 6 points to 8 percent of owners.

CAPITAL SPENDING

Sixty-one percent reported capital outlays, unchanged from November. Of those making expenditures, 42 percent reported spending on new equipment (down 3 points), 25 percent acquired vehicles (up 3 points), and 15 percent improved or expanded facilities (down 3 points). Six percent acquired new buildings or land for expansion (down 2 points) and 15 percent spent money for new fixtures and furniture (unchanged). Twenty-five percent plan capital outlays in the next 3 to 6 months, down 4 points.

INFLATION

Seasonally adjusted, a net 25 percent plan price hikes (down 4 points). The net percent of owners raising average selling prices rose 1 point to a net 17 percent, also seasonally adjusted. Forty-eight percent of the firms in the wholesale trades reported raising, and 29 percent of the construction and retail firms hiked prices. In agriculture, 31 percent reported lower average prices (11 percent raised).

COMPENSATION AND EARNINGS

Reports of higher worker compensation rose 1 point to a net 35 percent of all firms. Plans to raise compensation fell 1 point to a net 24 percent, just below the November reading, which was the highest since 1989. Twenty-three percent (down 2 points from November’s record high) selected “finding qualified labor” as their top business problem, more than cited taxes or regulations as their top challenge. The frequency of reports of positive profit trends fell 3 points to a net negative 7 percent reporting quarter on quarter profit improvements. One-third of those reporting weaker profits blamed sales, only 4 percent blamed labor costs, and 21 percent usual seasonal change. For those reporting higher profits, 61 percent credited sales volumes, unchanged from November. Less than 10 percent of owners credited changing prices (up or down) for the results.

CREDIT MARKETS

Four percent of owners reported that all their borrowing needs were not satisfied, up 1 point but historically very low. Thirty-two percent reported all credit needs met (unchanged) and 50 percent said they were not interested in a loan, up 3 points. Five percent reported their last loan was harder to get than the previous one, unchanged and historically low. Only three percent reported that financing was their top business problem (up 1 point). The percent of owners reporting paying a higher rate on their most recent loan rose 5 points to 24 percent, the highest since 2007. Thirty-five percent of all owners reported borrowing on a regular basis (up 3 points). The average rate paid on short maturity loans rose 30 basis points to 6.4 percent.

COMMENTARY

Critics of the Federal Reserve are popping up everywhere. They say that the Federal Reserve is not paying attention to “what financial markets are telling” us about the economy. However, the stock market does not reflect the entire economy. The small business sector represents the other half and it continues its two-year run of record high performance levels, an important consideration. Critics have forgotten what impact zero interest rates have had. If investors can’t earn anything in bonds or savings accounts, they put their money into stocks and real estate, bidding up those prices. When interest rates start to normalize (i.e. rise), other investment options become more attractive.

The price of shares of stock in a company reflect the earnings the company is expected to make. The price of the share multiplied by the number of shares outstanding is the value of the company. Similarly, the value of our stock markets collectively reflect the value of the production of all of our publicly traded companies taken together. But again, that is not the full picture. Small businesses are not represented in the currently volatile stock market. In fact, small businesses have reported sales and earnings growth at record levels over the past 2 years and December’s report shows continued high levels of economic growth in the small business sector.

Share prices for publicly traded companies have not been connected to reality for some time, thanks to the Federal Reserve artificially holding interest rates down for so many years. Since 2008, the S&P stock index has risen 110 percent, but US output, measured by GDP, has increased only 25 percent over the same period. The growth in output owned by each share has lagged far behind the share price. So, as interest rates rise, bonds provide an attractive alternative to owning stocks and stock prices will weaken as investment money shifts to bonds.

Since the economy took off after the election, there have been two themes promoted by the press: (1) the economy is going to overheat and cause inflation and (2) the economy is slowing and the Federal Reserve should not raise interest rates. Over that period, the NFIB surveys of the “small business” half of the economy have shown that there was and is no inflation threat and now shows that in spite of the gloom and doom in the press, Main Street remains historically very strong, setting record levels of hiring along the way.

So, yes interest rates will rise and no, the Federal Reserve should not abandon its policy simply because the stock market is volatile. Normalizing interest rates means normalizing asset prices. Much of the “real” economy is at record high levels for this expansion. The Federal Reserve does want to get as far away from “0” interest rates as it can in anticipation of needed cuts in the future. But it will not do this by risking a recession. At full employment, the best they can do without pushing inflation is to keep the economy steady at its current high level of employment.