NFIB: July Not A "4 Percent GDP Month"

August 27, 2014

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In my regular monthly update of the data provided in the National Federation of Independent Business monthly small business survey, I attempt to look beyond the “headline spin” as to what the data is suggesting about the overall economy. I like the NFIB survey, in particular, as it provides insight to what is happening on the “front line” of the American economy. As a small business owner, the survey often has a high degree of correlation to my outlook and current experiences. Furthermore, this survey is one of the reasons why I have held my position that the recovery on Wall Street is far different from what is actually happening on “Main Street.”

The July survey is particularly interesting as it is the quarter-end survey which has the highest levels of participation as shown in the table below. From a statistical view, the higher sampling set gives a greater degree of confidence in the overall survey results.

In July, the survey rose to 95.7, up 0.7 points from June. While the headlines tout an increase in overall small confidence, the current level is still well below the 96.6 reading in May and only slightly above the 95.2 posting in April. In other words, after the initial “pop” following the winter “chill,” there has been little improvement in overall optimism by businesses.

As noted in the chart below, the surge in optimism last month has now returned the survey to levels normally associated with the onset of recessions.

However, the internals of the report were much less exuberant as noted by the NFIB:

“The Index of Small Business Optimism rose 0.7 points in July to 95.7, not a ‘4 percent’ GDP month for sure. There was little change in the 10 Index components other than outlook for expansion and business conditions which accounted for the small gain in the Index. Even though these improved, they remain historically low.”

The survey remains at concerning levels when considering that the economy is now entering into its sixth year of recovery. This is a fact that goes unnoticed by much of the mainstream analysis. The chart below shows the historical length of economic recoveries following recessionary periods.

The issue is that despite all evidence the contrary, there is a prevailing “blindness” to the reality of economic cycles. Economic recoveries are finite and by all measures the current economic recovery has been very long. While longer periods of economic expansion have certainly existed, the underpinnings of those expansions are substantially different than what exists currently.

However, while the media will certainly jump on the very “bullish” headline number of the survey, a deeper dive into the data gives us a better picture of the business owner sentiment.

The majority of the increase in “sentiment” in July by small businesses was a primarily a reflection of “expectations” rather than “actions.” From the NFIB:

“On the positive side expectations for business conditions and outlook for expansion accounted for virtually all of the net gain in July’s Index. However, capital spending reports continue to remain mediocre, spending plans are weak, and inventories are too large, with more owners reporting sales trends deteriorating than improving. As long as these stats continue to hold, the small business half of the economy will continue to not be able to pull its weight.” – Bill Dunkelberg, NFIB Chief Economist

The problem is that expectations are very fragile. Any stumble in the current environment will see those expectations quickly reverse. The chart below shows expectations of economic improvement (currently at -6%, down from 0% in May) as compared to plans for capital expenditures over the next 3-6 months (currently at 23%, down from 24% in May).

If small businesses were convinced that the economy was “actually” improving over the longer term, they would be increasing capital expenditure plans rather than reducing them. Furthermore, the expectations of economic improvement following the “winter slowdown” have dissipated along with the inclement weather.

From Bill:

“Year over year, GDP growth is running about 2.5 percent, been here, done that for too long now. Looking at the NFIB survey results for July, there is no evidence that economic activity is picking up in early Q3. Only job creation plans and job openings have reached growth levels from a historical perspective. But the actual reported job creation, though positive, is not strong. And capital spending and inventory investment both remain weak. Unfortunately, Q3 looks like more of the same.”

The disparity between improved economic outlook and capex plans is a likely reflection that business owners are hoping for increased economic activity. However, they are not willing to ‘bet’ their capital on it.

The divergence can also be seen between expectations to increase employment versus those that did. Three months ago, the percentage of respondents that were expecting to increase employment over the next quarter, or two, rang in at 10%. Three months later, the percentage of respondents that increased employment was 3%, that is lower than December in the middle of the “winter slowdown.” While “expectations” should be “leading” action, this has not been the case.

The first chart below shows the raw data of how firms feel “today” about increasing employment over the next three months versus actual increases in employment over the last quarter.

However, that doesn’t tell us much until we rearrange the data a bit. The chart below shows the difference between what owners “hiring plans” were three months ago versus what they actually did over the next quarter. As you can see, expectations of hiring were far more negative than actual employment activity during the financial crisis. However, since the financial crisis, actual employment has begun to align more closely with expectations but remains well below normal economic expansion levels.

Importantly, all “hiring” is not equal. This is a point lost on the majority of analysis pushed by the mainstream media to promote the “bullish view.” Full-time employment is what drives household formation and stronger economic growth. Unfortunately, this is what has been lacking in the equation. Bill Dunkelberg makes an astute observation on the employment front:

“But the unemployment rate went up, not down although some excuse this as typical in a recovery when more re-enter the labor force. Total hours worked by all these workers barely increased. The Index of Total hours rose from 100.8 to 101.0, 2007=100. So, the total number of hours worked is virtually the same as in 2007, seven years later and after five years of ‘expansion.’ Gains in part-time employment, offset by losses of full-time workers is not a good model for economic growth.”

The divergence between expectations and reality can also be seen in actual sales versus expectations of increased sales.

Despite hopes of increasing sales, business owners are still faced with actual sales that are still well below long-term trends. Since revenue is what ultimately drives expansion, it is not surprising that when asked whether this is a “good time to expand” their operations the large majority of responses remain negative. That view has remained unchanged since the depths of the financial crisis.

For small businesses, the overall environment remains very challenging. The top 3 concerns of small businesses remain government regulations, taxes and poor sales as shown by the composite indicator below. While improved somewhat from the financial crisis, levels remain well entrenched in recessionary territory.

Increased regulations, the onset of the Affordable Care Act (ACA), increased taxes (due to the ACA), and increased costs of compliance keep budgets tight with profitability a primary focus. Taxes and Government Regulations continued to be at the forefront of the decision-making process by business owners.

While the increase in the small business optimism is certainly a welcome sign, it is mostly a coincident increase rather than a leading indicator. I have repeatedly stated in the past that “market bulls” should hope that interest rates don’t rise. Bill Dunkelberg, Chief Economist for the NFIB, provided a clear warning in this regard:

“Job growth was anemic in July with 209,000 as a first guess by the BLS. But the media rejoiced calling it ‘not too hot, not too cold,’ just right for the Federal Reserve and the stock market. Really? Well, financial markets don’t want a hot economy because interest rates will rise causing asset values [to] fall.

The denominator in the valuation model is as low as it can be. But it’s the numerator, expected profits and cash flow that is being crippled by current policies and high levels of uncertainty. A third of the owners who view the current period as a bad time to expand blame the political environment.”

As I discussed yesterday, the statistics on the bulk of Americans are dismal. The gap between incomes and the cost of living is once again being filled by debt. However, using credit to maintain a standard of living is far different that using debt to increase it. This is why consumptions expenditures are weak and “final demand” in the economy remains anemic. In turn, business owners remain on the defensive, reacting to increases in demand caused by population growth rather than building in anticipation of stronger economic activity. What this suggests is that the current “struggle through” economy will persist leaving participants exposed to an unexpected exogenous shock.