NFIB Report September 2017: Expected Business Conditions Tumble

Bill Dunkelberg

The NFIB Index of Small Business Optimism tumbled in September from 105.3 to 103 led by a steep drop in sales expectations, not just in hurricane-affected states, but across the country.

“The temptation is to blame the decline on the hurricanes in Texas and Florida, but that is not consistent with our data,” said Juanita Duggan, NFIB President and CEO. “Small business owners across the country were measurably less enthusiastic last month.”

The number of small business owners who expected better sales plunged a net 12 points last month.  Owners who think that it’s a good time to expand dropped a net 10 points. Also within the Index, expected better business conditions (-6) and capital expenditure plans (-5) retreated in September.

“The drop-off was consistent around the country regardless of region, and it’s likely that members in Florida and Texas were underrepresented in this survey because of the obvious disruptions,” said NFIB Chief Economist Bill Dunkelberg. “The adjusted average employment change per firm dipped to -0.17, which is a significant drop in hiring activity.

“The Index remains very high by historical standards,” he continued. “Small business owners still expect policy changes from Washington on health care and taxes, and while they don’t know what those changes will look like, they expect them to be an improvement. But the frothy expectations they’ve had in the previous few months clearly slipped in September.”

Six of the 10 Index components dropped in September. Three improved, and one remained unchanged. The bright spot last month was inventory plans, which gained five points as more business owners anticipate a strong 4th quarter.

Job creation weakened in the small business sector as business owners reported an adjusted average employment change per firm of -0.17 workers. Decreases were reported by owners in six of the nine Census regions, so it wasn’t just a hurricane effect. Twelve percent (down 2 points) reported increasing employment an average of 2.7 workers per firm and 13% (up 1 point) reported reducing employment an average of 2.0 workers per firm (seasonally adjusted). Fifty-seven percent reported hiring or trying to hire (down 2 points), but 49% (86% of those hiring or trying to hire) reported few or no qualified applicants for the positions they were trying to fill. Nineteen percent of owners cited the difficulty of finding qualified workers as their Single Most Important Business Problem (unchanged), second only to taxes. This is the top ranked problem for those in construction (30%) and manufacturing (28%), getting more votes than taxes and regulations. Thirty percent of all owners reported job openings they could not fill in the current period, down 1 point. Eleven percent reported using temporary workers, down 2 points. A seasonally adjusted net 19% plan to create new jobs, up 1 point from August, a strong reading.

The net percent of all owners (seasonally adjusted) reporting higher nominal sales in the past three months compared to the prior three months was a net 1%, a 2 point decline from August. Seasonally adjusted, the net percent of owners expecting higher real sales volumes lost 12 points, falling to a net 15% of owners, this after large gains in July and August. What triggered such a large decline in expectations is less clear, as reports on the economy (e.g. 3.1% GDP growth in the second quarter etc.) were fairly good. Respondents in Florida and Texas were no less optimistic than their counterparts in the rest of the country. The net percent of owners reporting inventory increases fell to a net negative 2% (seasonally adjusted), a decline of 3 points, indicating more inventory reduction than in August. The net percent of owners viewing current inventory stocks as “too low” gained 2 points to a net -3%. The net percent of owners planning to add to inventory rose 5 points to a net 7%.

Fifty-nine percent reported capital outlays, down 1 point. Of those making expenditures, 39% reported spending on new equipment (down 3 points), 23% acquired vehicles (down 1 point), and 13% improved or expanded facilities (down 3 points). Six percent acquired new buildings or land for expansion (down 1 point) and 12% spent money for new fixtures and furniture (up 3 points). The percent of owners planning capital outlays fell 5 points to 27%. The recovery from the hurricanes will undoubtedly raise these numbers. Plans were most frequent in agriculture (29%), the wholesale trades (28%), and manufacturing (38%).

The net percent of owners raising average selling prices declined 3 points to a net 6%. Clearly, inflation is not “breaking out” across the country as the Federal Reserve hoped. Ten percent of owners reported reducing their average selling prices in the past three months (up 1 point), and 15% reported price increases (down 2 points). Seasonally adjusted, a net 19% plan price hikes (down 1 point), a figure that has typically been 2 to 3 times larger than the percent that a month later report actually raising prices.

Reports of higher worker compensation fell 3 points to a net 25%, still historically strong. The Federal Reserve is hoping this will result in inflation as owners pass these costs on in the form of higher selling prices, but to date, their wish has not been granted to any significant degree. Plans to raise compensation rose 3 points in frequency to a net 18%, a logical response to labor market tightness. The frequency of reports of improved profit trends was unchanged at a net -11% reporting quarter on quarter profit improvements, historically a solid reading and one of the best readings in this expansion.

Two percent of owners reported that all their borrowing needs were not satisfied, down 1 point and historically very low. Thirty-three percent reported all credit needs met (down 1 point) and 51% said they were not interested in a loan, up 2 points. Only 1% reported that financing was their top business problem compared to 21% citing taxes, 16% citing regulations and red tape, and 19% the availability of qualified labor. Twenty-nine percent of all owners reported borrowing on a regular basis (down 2 points). The average rate paid on short maturity loans was up 10 basis points at 5.6%, little changed even as the Federal Reserve raises rates.

Second quarter GDP growth was revised upward to 3.1%, the best growth rate in years. Third quarter growth will be hampered by the hurricanes in our 2nd and 4th largest states. Shopping was difficult without a boat and if your boat made it to your workplace, it may have been flooded or without power. Rebuilding will add to growth in the fourth quarter, but replacing assets that were lost is not an optimal use of funds, even if necessary. It only replaces wealth lost rather than adding new productive assets to our economy. Third quarter estimates of growth from the Atlanta and New York Federal Reserve Banks range from 2.7% to 1.5% respectively. Another 3% growth quarter is not likely for Q3. However, Q4 is shaping up to be better, even before hurricane recovery stimulus.

The Federal Reserve announced the plan to reduce its $4.5 trillion portfolio. Other things equal, the withdrawal of Federal Reserve demand for Treasury bonds to replace those coming due will put an upward pressure on interest rates. However, other factors such as foreign demand for U.S. securities could easily overwhelm this in the early stages of portfolio reductions. The Federal Reserve will raise its benchmark rate in December in an attempt to produce a federal funds rate that is more “normal” and further away from the “zero floor,” just in case the economy falters and the Fed needs to cut rates.

Owner optimism posted a decline but remained historically very high, driven primarily by reduced optimism about sales, business conditions and the environment for expanding a business. However, fundamental Index components were stronger, with gains in hiring plans and inventory investment plans. Capital spending plans were weaker but down from a very high level last month, returning to levels more typical this year. With recent improvement in other economic indicators including the September ISM Non-Manufacturing Index which is at its highest since 2005, and the prospect of recovery spending, the fourth quarter doesn’t look bad at all.

Bill Dunkelberg is chief economist of the National Federation of Independent Business (NFIB).

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