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posted on 12 September 2017

August 2017 Small Business Optimism - Surge In Capital Spending and High Sales Expectations

from the National Federation of Independent Business

The Index of Small Business Optimism rose 1.6 percent in July to 105.2, a strong performance led by significant gains in hiring activity.

[editor's note: Market expectation from Bloomberg / Econoday was between 103.0 to 105.9 (consensus 104.8) versus the actual reading of 105.3.]

Said NFIB President and CEO Juanita Duggan:

This is a sign of economic health that we've been expecting based on the soaring optimism that began last year. Higher optimism resulted first in higher employment activity, and now we're seeing more small business owners making capital investments.

Consumer demand is very strong, and the regulatory relief has been dramatic. Small business owners still expect progress on tax reform and healthcare, and they will be watching closely.

Consumer demand is driving optimism, and optimism is driving business activity. Substantial regulatory relief is also a big factor because it creates a much more hospitable business climate.

Among the 10 components that make up the Index, seven improved, two declined, and one remained unchanged. The biggest gains were: job openings (+5); job creation plans (+4); and sales expectations (+5).


Said NFIB Chief Economist Bill Dunkelberg:

The August figures for capital outlays are typical of a growing economy.

Small firms are now making long-term investments in new machines, equipment, facilities, and technology. That's a real sign of strength, and it will be interesting to see if the August result becomes a trend.


Report Overview:

The Index of Small Business Optimism rose 0.1 points to 105.3 in August, basically unchanged from July. Five of the 10 Index components posted a gain and five declined. The Index peaked for this recovery at 105.9 in January, just 0.6 points above the August reading. It is unlikely that progress in Washington D.C. is the source of continued owner optimism because there isn't any on the major issues of health care and tax reform. So owner optimism is more like a "relief rally", relief that they did not get another four years of costly federal regulations which increased the hold of government on the private sector. The Congressional Record is nearly empty compared to years of record new and changed regulations posted for the past eight years.

Labor market indicators point towards a likely continuation of good jobs reports. Reports of increases in compensation remained at historically high levels. The frequency of reported price increases was the highest since 2014, but still historically low. Inventory investment plans faded but were still solid. Reports of capital outlays surged along with the percent of owners viewing the current period as a good time to expand. Expectations of higher real sales posted strong gains, anticipating a stronger second half of 2017.

Some other highlights of this Optimism Index include:

Labor Markets. Small business owners reported a seasonally adjusted average employment change per firm of 0.18 workers per firm over the past three months, virtually unchanged from July. Fourteen percent (up 1 point) reported increasing employment an average of 4.4 workers per firm and 12 percent (up 1 point) 3 reported reducing employment an average of 2.4 workers per firm (seasonally adjusted). Fifty-nine percent reported hiring or trying to hire (down 1 point), but 52 percent (88 percent of those hiring or trying to hire) reported few or no qualified applicants for the positions they were trying to fill. Nineteen percent of owners cited the difficulty of finding qualifed workers as their Single Most Important Business Problem (unchanged), second only to taxes. Labor quality is the top ranked problem in Construction (33 percent) and Manufacturing (25 percent), receiving more votes than taxes and regulatory costs. The most typical reason for "disqualification" of an applicant was a lack of specific job skills (cited by 26 percent of employers), followed by a poor work history (16 percent). Poor English and math skills typically disqualified 10 percent of the applicants. A lack of social skills disqualified 14 percent, unreasonable wage expectations 14 percent, attitude 12 percent, and appearance 8 percent, all factors that the applicant could easily improve without additional training if they really wanted a job. Drug issues were a typical reason for disqualification for 10 percent of the owners and legal status for 6 percent. Thirty-one percent of all owners reported at least one job opening they could not fill in the current period, down 4 points but a very high reading. Thirteen percent reported using temporary workers, down 1 point. Reports of job openings were most frequent in Construction (54 percent), Manufacturing (37 percent) and Retail (34 percent). A seasonally adjusted net 18 percent of owners plan to create new jobs, off 1 point from July but historically very strong. Not seasonally adjusted, 20 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 and Manufacturing where job openings are most frequent. Residential construction would be stronger if builders were able to find more qualified workers and fill their open positions.

Credit Markets. Three percent of owners reported that all their borrowing needs were not satisfied, unchanged and historically very low. Thirty-four percent reported all credit needs met (up 3 points) and 49 percent explicitly said they were not interested in a loan, down 2 points. Including those who did not answer the question, 63 percent of owners have no interest in borrowing, down 3 points. Only 2 percent reported that financing was their top business problem compared to 20 percent citing taxes, 16 percent citing regulations and red tape, and 19 percent the availability of qualified labor. Weak sales garnered 9 percent of the vote. Thirty-one percent of all owners reported borrowing on a regular basis (up 1 point). The average rate paid on short maturity loans was down 40 basis points at 5.5 percent, little changed even as the Federal Reserve raises rates. Overall, loan demand remains historically weak, 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.

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 3 percent, a 3-point improvement over July. Improved consumer spending is showing up on Main Street, with help from residential construction and home sales that are buoying firms in construction, finance, insurance and real estate, all large segments of the small business sector. Seasonally adjusted, the net percent of owners expecting higher real sales volumes gained 5 points, rising to a net 27 percent of owners, this on top of a 5- point jump in July. Stronger sales expectations are very supportive of the historically high hiring plans and strong inventory investment plans.

Inventories. The net percent of owners reporting net inventory increases was unchanged at a net 1 percent (seasonally adjusted), reversing months of inventory stock reductions that were generated by solid consumer spending in the second quarter. The net percent of owners viewing current inventory stocks as "too low" deteriorated 3 points to a net negative 5 percent. The net percent of owners planning to add to inventory fell 3 points to a net 2 percent. Although lower than July's reading, this is a positive indicator for second half growth and consistent with the improvement in real sales expectations and future business conditions.

Capital Spending. Sixty percent reported capital outlays, up 3 points. Of those making expenditures, 42 percent reported spending on new equipment (up 4 points), 24 percent acquired vehicles (unchanged), and 16 percent improved or expanded facilities (down 1 point). Seven percent acquired new buildings or land for expansion (up 2 points) and 9 percent spent money for new fixtures and furniture (down 4 points). Solid numbers, but not enough for a significant improvement in GDP growth or productivity. The very low frequency of capital investments over the past ten years has undoubtedly negatively impacted productivity growth in the small business sector and created a drag on the growth of overall U.S. productivity. Capital investment at large businesses has also been weak. A substantial amount of capital has been expended over this period in compliance with regulations that have not raised productivity and are of dubious value to consumers. Reversing this trend will contribute to an increase in productivity-enhancing capital spending. The percent of owners planning capital outlays in the next 3 to 6 months increased to 32 percent, the strongest reading since 2006. Investment plans have risen to levels more typical of a growing economy. Plans were most frequent in Professional Services (46 percent), Agriculture (33 percent), the Wholesale Trades (36 percent), Manufacturing (38 percent each) and Construction (33 percent).

Compensation and Earnings. Reports of higher worker compensation continue to be strong, consistent with the tight labor markets indicated by the job openings and complaints about labor quality. Reports of increased compensation rose 1 point to a net 28 percent. 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. Owners complain at record rates of labor quality issues, with 88 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 their top challenge. Plans to raise compensation fell 1 point to a net 15 percent, the lowest reading this year. But labor market conditions will result in many more actually raising compensation, to keep or attract the employees they need. The frequency of reports of improved profit trends declined 1 point to a net negative 11 percent reporting quarter on quarter profit improvements, historically a solid reading and one of the best readings in this expansion. In spite of rising labor costs, owners are seeing decent bottom line performance. Most of those reporting higher profits credit improved sales, just 14 percent said higher selling prices improved the bottom line.

Inflation. The net percent of owners raising average selling prices increased 1 point, rising to a net 9 percent. This is the highest reading since 2014, and good news for the Federal Reserve which is trying to generate more inflation. Nine percent of owners reported reducing their average selling prices in the past three months (unchanged), and 17 percent reported price increases (down 1 point). Seasonally adjusted, a net 20 percent plan price hikes (down 3 points). If expectations for sales volumes are realized, some of the price hikes may stick. The Federal Reserve should be delighted that inflation has remained well below 2 percent as the economy continues to grow. There is nothing "magic" about 2 percent inflation, and danger associated with trying to create more inflation as a matter of policy. Two percent inflation reduces the purchasing power of the dollar over 20 percent in ten years. That's a lot of depreciation, unhealthy for savings accounts. The Federal Reserve assumes that as compensation rises, prices will follow, creating the inflation they are looking for. Although there is a positive correlation between labor cost increases and price increases, it is not perfect, indicating that there are other intervening factors that shape just how quickly labor costs are passed on to customers in higher prices.

source: NFIB

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