NFIB: Outlook Improves, But Is It Just Coincidental?

June 15, 2014

28

Note from dshort: Earlier today I posted my quick overview of the NFIB Optimism Index. I then eagerly awaited the more detailed analysis by my friend and small businessman Lance Roberts, reprinted below.

I regularly analyze the data provided by the National Federation Of Independent Business monthly small business survey 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 own outlook and current experience. 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.”

In May the survey rose to 96.6, up 1.4 points from April, and is now at the highest level since 2007. 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 four components most closely related to GDP and employment growth (job openings, job creation plans, inventory and capital spending plans) collectively fell 1 point in May. So the entire gain in optimism was driven by soft components (sales expectations and business conditions). If these translate into more spending and hiring, growth will get a boost. However, this ‘optimism’ has not translated into more debt financed spending.”

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.

As noted above by the NFIB, the majority of the increase in “sentiment” by small businesses was a primarily a reflection of “expectations” rather than “actions.” The problem is that those expectations are very fragile, and any fault in the current environment will see those expectations quickly reverse.

The chart below shows expectations of economic improvement (currently at 0%) as compared to plans for capital expenditures over the next 3-6 months (currently at 24%).

If small business were convinced that the economy was “actually” improving over the longer term, they would be increasing capital expenditure plans rather than reducing them. However, the disparity between improved economic outlook and capex plans is most likely a reflection that business owners are indeed expecting a temporary bounce in economic activity following the winter “slowdown” but not much more than that. As I stated in the March update:

“Some of this increase in optimism could certainly be attributed to a ‘thawing’ of attitudes following the repeated blast of freezing temperatures, and inclement weather, during the first quarter of the year.

You would expect that if businesses were planning for a relatively sharp uptick in real sales in the months ahead, that they would be making changes to accommodate the increased demand. Yet, the data suggests that business owners may just be ‘hoping’ that sales will increase, but not willing to ‘bet’ their capital on it.

The divergence can also be seen between expectations to increase employment versus those that actually did. Three months ago, the percentage of respondents that were expecting to increase employment rang in at 5%. Three months later, the percentage of respondents that actually increased employment was -1% which was at exactly that level three months ago. 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 3 months versus actual increases in employment over the last quarter.

However, that really doesn’t tell us much until we rearrange the data a bit. The chart below shows the difference between what owners “hiring plans” were 3 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 plans to increase employment have outpaced actual activity.

The same issue can be seen between 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 remains 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 than a leading indicator. As Bill Dunkleberg, Chief Economist for the NFIB, stated:

“The Index continued to improve, to the highest level since September 2007. That’s the good news. Three gains in a row – could be the start of a trend, although we have had quite a few of these along the way that didn’t pan out.”

Over the last five years we have seen economic growth sputter, rebound and then sputter once again. These fits and starts have been driven much by the Federal Reserve’s artificial interventions. With the Federal Reserve once again withdrawing support, it is quite likely that we will see the current recovery once again fade.

However, for the moment the financial markets are surging higher on the back of elevated expectations about an infinite cycle of economic growth. The reality, however, is always quite different. From Bill:

“The ‘bifurcation’ continues, with the S&P 500 hitting new record highs while the output of the firms being valued (GDP) fell 1 percent at an annual rate in the first quarter and the second quarter seems off to a weak start. Profit performance was not great (down 34 percent at an annual rate, down 4 percent year over year) but this did not deter investors who were further enticed to buy equities by a bond market rally. Although the Federal Reserve has declared that we are wealthier than at any time in history, it doesn’t feel that way.

All that wealth isn’t producing much consumer spending. Consumption is estimated to rise 2 cents for every dollar increase in stock market wealth and 10 cents for every dollar in housing wealth, thought to be more permanent, at least until the housing bubble burst. And it is hard to believe that after the housing bubble and the worst recession since the Depression, that we could be so wealthy so quickly. Perhaps the values we are attaching to the assets we all own are not realistic (viz. the Fed’s distortion of a very important price, interest rates).“

Of course, the reality is that the majority of the population owns very little, if any, of the stock market assets. This is why there continues to be a real divergence between the “rich” and the “poor.” Housing prices are indeed rising which is a good thing if you are a seller. However, if you are a homeowner then taxes and other ancillary ownership costs have continued to rise while incomes have lagged. Rising taxes, healthcare costs, and increased living expenses are negatively impacting the standard of living of many Americans. The gap between income and costs is once again being filled by debt. However, use credit to maintain a standard of living is far different that using debt to increase it. This is why consumption expenditures remain weak which continues to fuel the shortfall in meeting expectations.