Record High Small Business Sentiment

Small Business - Record High Optimism

The NFIB small business optimism index was up from 107.9 in July to 108.8 in August. It beat the consensus for 108.1 and the high end of the range which was 108.5.

This was the highest reading in the 45 year history of the report. You can see in the first chart below that the index spiked after the 2016 election and has increased since then.

Firms love the tax cuts, regulation cuts, and the strong dollar. There has been about 2 years of euphoria in this index. This has translated into solid economic growth, strong consumer spending growth, and appreciation in the stock market.

As you can see from the second chart above, firms think now is a great time to expand because the economy is strong.

The net percentage of small businesses who said now is a good time to expand increased 2 points to 34%.

The bottom chart above shows the planned hiring and job openings indexes also increased. The net businesses reporting job openings they could not fill increased 1% to 38% which is a record high.

This looks just like the JOLTS report which I will review later. Both of those reports are different from the prime age labor force participation rate which signals there is still slack in the labor market.

As you can see from the chart above, the net percentage of firms planning capital expenditures in the next 3 to 6 months was up 3 points to 33.

This is the highest reading since 2007. As you can see, it still has room to increase a few points as it hit 40% in the 1990s.

Small Business - If this cycle reaches the height of the 1990s, it will probably last 1-2 more years.

Some look at the 2000s cycle and the 1990s cycle as equally likely to occur because they were the two most recent ones.

However, since there isn’t a bubble in the largest asset consumers own and oil isn’t at $147, I think it’s fair to ignore the last cycle.

That’s probably an obvious assumption at this point since this expansion has been much longer than the 2000s expansion and growth in consumer spending has come without excess leverage.

The household debt to GDP ratio has actually fallen by about 30%.

Small Business - Inventory Investment Should Help Q3 GDP Growth

6 of the 10 indexes in the small business sentiment report increased and 4 decreased. The best index was the plans to increase inventories.

The net percentage of firms planning to increase inventories increased 6 points to 10. That was the highest reading since 2005. This is in tune with the overall economy. Q2 GDP growth was limited by inventory investment.

Even if underlying growth in Q3 is weak, Q3 GDP growth will probably be above 3% because of inventory investment.

The CNBC rapid update, which includes 12 estimates, shows the median estimate for Q3 GDP growth is 3.2%.

Finally, the two segments in this sentiment report which had the largest decline were the expectation for real sales to increase and current inventory as both fell 3%.

The net expecting real sales to increase was 26% which is still strong. The fact that the current inventory segment fell to -3% explains why inventory investment should increase in the coming months.

Small Business - Is Optimism A Bad Thing?

The most common analysis on the small business index when optimism is high states that it’s a bearish sign.

I think this occurs because the facts are bullish themselves, so there’s not much for the bulls to say. The bears spin this as bad news by stating that the previous times the index has been high, recessions have soon followed.

The Russell 2000’s annualized return when the small business optimism index is above 107 is -3.5%. However, I continue to believe that optimism is good.

My retort to that stat is the average return is manipulated by large negative returns during recessions. If stocks increase by about 10% per year for 2 years after the optimism is high and then fall 50% in the third year, the average is negative.

The median returns are higher. Optimism doesn’t beget pessimism unless there is a negative catalyst. The bears have been saying strong small business confidence is bad news for 2 years, yet stocks have been increasing since then.

If stocks move up another year, they will still be bearish. At some point the index will obviously fall, but it currently doesn’t suggest anything bad will happen soon.

Small Business - Strong JOLTS Report

The Job Openings and Labor Turnover Survey shows the labor market is the most fantastic it has been since December 2000 when it started.

The June job openings were revised from 6.662 million to 6.822 million. The July openings were 6.939 million which beat the consensus for 6.67 million. It also beat the highest estimate which was 6.9 million.

As you can see from the chart below, the ratio of non-farm jobs to unemployment is higher than the previous two cycles’ peaks. The gap between openings and the number of people looking for work increased to 659,000.

Openings were up 1.7% in July and hires were flat after declining 1.2% in June. Year over year, openings were up 11.9% and hiring were up 3.3%. Employers need to raise wages if they want to hire talent with the right skills and experience. The quits rate increased 0.1% to 2.4%, showing us workers are confident in the labor market.

Small Business - Conclusion

Small businesses are very optimistic and workers are confident in the labor market. The biggest divergence is between what employers want to pay their workers and what workers with the correct experience and skills need to be paid.

If employers start reaching for qualified workers, wage growth will increase rapidly. That means inflation will eventually increase.

Rate hikes will follow inflation and eventually push the economy into a recession. We’re still over a year away from a recession because wage growth hasn’t exploded and the Fed still has accommodative monetary policy.

 

 

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