Small Business Optimism Creeps Upward but Recession Still a Concern

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The National Federation of Independent Business Index of Small Business Optimism rose 2.9 points to 91.1 in August, but continued one of the longest strings of recession-level readings in the history of the survey - dating back to 1973.

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This indicates a surprising surge in optimism about the economy for the second half of 2008

The National Federation of Independent Business Index of Small Business Optimism rose 2.9 points to 91.1 in August, but continued one of the longest strings of recession-level readings in the history of the survey - dating back to 1973. Two-thirds of the gain was due to a new confidence among small business owners who expect business conditions to improve over the next six months.

"The direction of change was nicely positive,'' said NFIB Chief Economist William Dunkelberg, ''but we have a long way to go. We appear to have a 'depression' in expectations, but a more modest 'recession' in spending and hiring. That explains why the economy continues to muddle along."

Please see the attached table for a breakdown of the components and the changes from last month's Index.

Seasonally adjusted, average employment per firm declined by 0.04 workers in August, better than in July, but still on the negative side. Eleven percent of the owners increased employment by an average of 5.7 workers per firm, but 15 percent reduced employment an average of 3.7 workers per firm (seasonally adjusted). Productivity was unexpectedly strong, suggesting that labor hours were reduced at a faster pace than output fell.

Forty-six percent of the owners hired or tried to hire (down three points) and 76 percent of those trying to hire reported few or no qualified applicants for the job openings they want to fill. Nine percent reported that the availability of qualified labor was their top business problem, a point lower than July. Fifteen percent (seasonally adjusted) reported unfilled job openings, down 2 points from July (the 34 year average is 22 percent), confirming the NFIB forecast of unemployment rates in excess of 6 percent in the months to come.

Over the next three months, 13 percent plan to create new jobs (up one point), and 10 percent plan workforce reductions (unchanged), yielding a seasonally adjusted net 9 percent of owners planning to create new jobs, four points better than July.

The frequency of reported capital outlays over the past six months rose two points to 54 percent of all firms (up 2 points), still at recession levels. "While Fed policy may be keeping financing costs low, the weak economy has reduced the need for expansion and new equipment and put pressure on cash flows, inducing owners to postpone discretionary capital outlays," Dunkelberg said. Thirty-nine percent of those surveyed reported spending on new equipment (up a point), 22 percent acquired vehicles (up three points), and 14 percent improved or expanded their facilities (up four points). Fourteen percent spent money for new fixtures and furniture (up four points), and 4 percent acquired new buildings or land for expansion (down a point).

Plans to make capital expenditures over the next few months rose two points to 23 percent, historically very weak. Six percent said the current period is a good time to expand facilities, unchanged from July and also historically low. A net 4 percent expect business conditions to improve over the next six months, 21 points better than July. "This indicates a surprising surge in optimism about the economy for the second half of 2008," the economist said.

Expectations for gains in real sales also improved, rising three points to a net-negative 6 percent of owners expecting improvements. More owners expect declines than gains, but the margin is shrinking. Profit trends also improved, a positive for future capital spending, but those reporting declines still exceeded those reporting gains by 30 points.

Small business owners are shedding inventory. A net-negative 13 percent of owners reported gains in inventory stocks (more firms cut stocks than added to them, seasonally adjusted), the fifth negative, double-digit month in a row. Unadjusted, 11 percent reported gains, and 23 percent reported inventory reductions.

Those reductions do not reflect increased satisfaction with current stocks because sales have also weakened, reducing the need for more inventory in the near future. For all firms, a net-negative 3 percent reported stocks too low (seasonally adjusted), one point better than July. More firms are reporting deteriorating sales trends than sales gains, quarter over quarter. The net percent of all owners (seasonally adjusted) reporting higher sales in the past three months gained five points, improving to a net negative 10 percent. Unadjusted, 27 percent of all owners reported higher sales, and 29 percent reported lower sales.

The net percent of owners expecting gains in real sales volumes improved to a net-negative six points (up three points) seasonally adjusted, still 20 points below last September's reading, but five points better than the May-June readings. Although the outlook is improving, owners were still surprisingly cautious, with a net-negative 9 percent of all firms, seasonally adjusted, planning to add to stocks. Seasonally unadjusted, 9 percent plan to add to stocks (down a point) while 20 percent will reduce stocks (up 4 points).

"The inflation picture remains sour," Dunkelberg said. "The good news is the net percent of owners reporting higher average selling prices dropped 6 points to a net 26 percent in August (seasonally adjusted); the bad news is that this is still one of the highest reading since the early 1980s." Unadjusted, 38 percent reported raising average selling prices, down four points, and 13 percent reported lower selling prices, up two points from July. The percent of owners citing inflation as their No.1 problem fell two points to 18 percent. Inflation and weak sales are tied for the most important business problem among small business owners. To put this in perspective, since the monthly surveys were started in 1986, the average percent of owners citing inflation as the No.1 problem is 3 percent.

"Plans to raise prices fell eight points to a seasonally adjusted net 30 percent," said Dunkelberg. "That is really high, but the decline in plans to raise prices further is welcome."

Earnings gains improved modestly in August. Seasonally adjusted, those reporting declining earnings outnumbered those with gains by 30 percentage points, a seven point gain. Widespread price increases may have offset some of the pressures from backdoor inflation and weak sales. The percent of all firms reporting higher employee compensation was unchanged, holding at a net 18 percent of all firms.

Of the owners reporting higher earnings (17 percent, unchanged), 53 percent cited stronger sales (unchanged) as the cause and 12 percent credited higher selling prices (unchanged). For those reporting lower earnings compared to the previous three months (41 percent, down seven points), 41 percent cited weaker sales (up a point), 27 percent named higher materials costs (read "energy"), 10 percent named lower selling prices, 5 percent each blamed higher taxes and higher labor costs. Two percent cited higher insurance costs.

A year has passed since the Fed declared the existence of a "credit crunch", but no evidence of serious credit problems has appeared on Main Street. "It remains a Wall Street issue, although some small-business owners probably did have loans at the mega banks and may have noticed a problem," said Dunkelberg. Regular borrowing activity was reported by 34 percent of the owners, unchanged and typical of readings for the past 15 years.

The net percent of owners reporting loans harder to get in recent months rose one point to a net 10 percent. In 2003, only 3 percent reported loans harder to get.

"The data make it clear that there was no 'seizing up' of credit markets, no 'frozen' supply, no sudden reduction in credit availability to Main Street firms as portrayed in the media," said Dunkelberg. "A slowdown in the economy also changes the credit worthiness of potential borrowers as sales and profits decline. Thus, even with no change in credit standards, more rejections will occur. And, many credit-worthy borrowers don't need credit in a period when business expansion makes no sense and inventories are being reduced, not increased. Thus, the aggregate amount of business loans can fall with no change in credit standards."

Only 2 percent of the owners cited the cost and availability of credit as their No.1 business problem (down a point), far from the record 37 percent reached in 1982. Thirty-five percent reported all their borrowing needs met (up three points) compared to 6 percent who reported problems obtaining desired financing (down a point), among the best readings this year.

The net percent of owners expecting credit conditions to ease in the coming months was a seasonally adjusted net-negative 11 percent (more owners expect that it will be "harder" to arrange financing), one point better than July (the average was negative 8 in 2007).

NFIB's Small Business Economic Trends is a monthly survey of small business owners' plans and opinions. Decision makers at the federal, state and local levels actively monitor these reports, ensuring that the voice of small business is heard. The NFIB Research Foundation conducts some of the most comprehensive research of small business issues in the nation. The National Federation of Independent Business is the nation's leading small business association. A nonprofit, nonpartisan organization founded in 1943, NFIB represents the consensus views of its members in Washington and all 50 state capitals.


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