Today the ADP report came out, with small businesses showing weakness. It wasn’t a great report when looking at the headline as the report showed 147,000 jobs created which was 18,000 below expectations. However, if you look deeper into the report, it looks even worse as small business job growth was the weakest category. Small business jobs growth represents about 2/3rds of the jobs created in the economy. If this is weak, it doesn’t bode well for the labor market. This is similar to how when I broke down the GDP report it showed the consumer weakening. Consumer spending represents about 2/3rds of GDP. In summary, the biggest creator of jobs is weakening and the biggest contributor to GDP growth is weakening as well. I am expecting a weak holiday shopping season as a result.
The chart below shows the ADP report of private non-farm payrolls. The growth in 147,000 jobs is the weakest month since May of 2016. It’s the 3rd worst report in the past 12 months.
While this economic recovery has been weak in terms of private sector jobs growth, the two best groups showing jobs created are the businesses with 1-19 and 20-49 employees. As I said, small businesses create most new jobs. This is supported by the chart below.
October was a terrible number for small business jobs growth. Of the 147,000 jobs created, only 34,000 of the jobs were created by small businesses. The very small businesses did the worst. Very small businesses created 14,000 jobs, while the other small businesses created 20,000 jobs.
There are many reasons why small businesses are doing poorly. One potential reason could be the decline in consumer spending we saw in the Q3 GDP report. This is related to the ending of the business cycle. The current environment favors large businesses because low interest rates let them borrow money to buy back stock. This is why we’re seeing the S&P 500 make new highs while the Russell 2000.
We’re also seeing an influx of merger and acquisitions. This is happening because sales growth is tough for large companies to obtain without making a deal. If the end market isn’t growing, the only way to grow the business is to gain market share. The easiest way to gain market share is to buy a competitor. With interest rates low, the ability to do these deals is easier than ever.
As you can see from the chart below, the dollar value for mergers in October is the largest in 12 years. When you have big companies buying smaller ones, there ends up being a net effect of jobs losses because the big companies fire some of the new workers who do the same tasks in both firms (synergies). Bigger companies increasing their market share makes it more difficult for small firms to compete. This trend signals a peak in the economy as the craziest, most risky deals happen when management is the most desperate for growth. Somewhere between the end of the year and the end of 2017 would be the end of this cycle according to the chart below if it takes a similar track to past cycles.
There has been a longer term problem with small businesses as well. This has been caused by increases in regulations. Small businesses cannot afford to spend money to figure out how to pass through all the hoops the government creates. One example which comes to mind is Dodd-Frank which hurts community banks.
The chart below shows the number of U.S. companies publically listed. Some of the mergers aimed to provide growth and create synergies don’t work out. I focus on social media, so I’ll give you example from there. Twitter acquired Vine in 2012 for $30 million and recently announced it would be shuttering it in the next few months. Maybe if Vine wasn’t bought by Twitter, it could have figured out how to monetize itself like Snapchat is doing. Vine didn’t have any pressure to monetize itself while being owned by Twitter.
A lot of times bigger companies acquired smaller ones to boost revenue growth without paying attention to profitability or understanding how to grow the business and integrate it properly into the larger one. An example of this would be IBM which can’t obtain revenue growth even with these types of acquisitions. It is simply chasing growth while ballooning the debt on the balance sheet.
To support the claim that the economy hasn’t recovered and possibly refute how strongly the ADP reports have shown jobs being created by small businesses this recovery cycle, I have the chart below. Startup creation is at a 40 year low according to 2014 census data. 453,835 new businesses were created in 2014 which is lower than the 500,000 to 600,000 firms created per year from the 1970s to the mid-2000s. This supports the idea that the period following 2007 was the start of an elongated depression. The past recovery reached lower highs in terms of GDP growth per capita. I believe the next recession will be worse than 2008.
Conclusion
The economy has been showing cracks all year, with this latest ADP report reinforcing this trend. The headline report missed expectations by 18,000 and showed small business job growth as the weakest category. If small business job growth weakens further we will see the labor cycle fully roll over. The BLS non-farms payroll data is reported Friday. I can’t help but be skeptical of what the report will show given the election is next week.
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