NFIB: Processing Error Removes Optimism

October 8th, 2013

by Lance Roberts

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Each month I continue to update our analysis of the small business survey when it is published by the National Federation of Independent Business (NFIB). While this survey doesn't get a tremendous amount of press, as a small business owner myself, I find its results more aligned with what I am seeing in the "Main Street" economy versus what the government reported data suggests. The most recent report continues to show a divergence between the recent improvement in the government report regional surveys and what small businesses are currently experiencing. The most report showed a decline in the small business confidence index from 94.1 last month to 93.9 in September.

In last month's report entitled "Small Business Going Nowhere" there were some anomalies in the data that showed sharp divergences from the recent data trends. I stated then:

"While the total reading showed essentially no change over the month prior, a look at the individual indicators reveals incongruent details.

One of those incongruences in particular was in job creation plans the jumped to a level not seen since before the last recession. However, that increase is not supported by the dramatic deterioration in real sales. The chart below shows the very abnormal divergence between actual sales versus sales expectations. The problem is that real sales tends to lead expectations which would mean that we may have seen the peak of expectations currently.

The favorable employment plans also contrasted sharply with the increasingly negative expectations of future business conditions. While there had been some recent improvement in recent months from historically low levels at the end of 2012 - outlooks remain at very recessionary levels."

This month those inconsistencies that I detailed were revealed to be a processing error according to the NFIB:

"Well, a processing error produced a few 'interesting' results in the details in the August data such as a surge in job creation plans and major declines in reported sales. But with the correction, most of the 10 Index components were little changed, with the exception of expected business conditions 6 months ahead which gave up 8 points. This could have been a result of the pending government shutdown and the exaggerated political rhetoric spewed into the media, although there was no difference in responses among those received in the first 20 days and the last 10 days of the month."

Bright Spots

However, despite the revisions to the data, there were some bright spots in the report.

Capital expenditure plans increased to 25% as businesses continue to look for ways to offset the need for increased employment.

However, it is important to understand that there are two factors that must be taken into account. First, these are "expectations " about future increases which may, or may not, actually occur; and 2) the levels of "capex" plans are still at levels normally associated with recessionary behavior.

The reality is that "labor hoarding" continues to push companies to make capital expenditures to increase productivity while increasing wages modestly to maintain critical staff. While expectations for hiring has improved in recent months there has not been a translation into actual employment to any great degree as hiring has remained primarily a function of population growth.

Other bright spots included an increase in expected real sales and those thinking this is a "good time to expand." The chart below shows real sales, expectations and the measure of a "good time to expand."

Real sales tend to lag sales expectations so the recent uptick in sales expectations is a positive. However, due to the government "angst" over the debt ceiling debate we could see this reverse in the next month or so. It is also important to understand that "real sales" is what drives business expansion. All three measures, while modestly improved in the latest report, all remain mired at levels normally witnessed at recessionary troughs rather than four years into an economic expansion.

The Negatives

The negatives to the report came in reductions to outlooks on employment plans which fell by 1% to a net of 9%, expectations of economic improvement which fell by 8% to a -10% (the revision to last month's data) and a -2% decline in earnings trends which corresponds to the weaker outlook for corporate earnings.

While the world is currently glued to the events surrounding the debt ceiling debate and budget battle; small business are more focused on the actual demand that drives the real economy. Real employment remains weak and corporate earnings are struggling given the diminishing returns of cost cutting.

The NFIB stated:

"While it is premature to measure the impact of the government shutdown on the small business sector, it's possible that the pending 'crisis' impacted economic outlook. October's reading will reveal the full effect of Washington's latest crisis on the small business sector, which has remained cautious throughout the recovery."

The current survey suggests that the economy is still stuck in "struggle mode" and an acceleration above 2% real economic growth is currently unlikely. The divergence between expectations and real demand will likely converge in the next couple of months further confirming this view. This point was confirmed by NFIB's chief economist Bill Dunkelberg who reiterated:

" The change in this month's Index was little more than 'statistical noise,' but the drop in outlook for future economic conditions is evidence that many owners are keeping an eye on Washington. Prospects for politicians and policymakers 'getting it right' are low, and job creators are rolling their eyes and shaking their heads thinking, 'This is certainly not the way to run the largest enterprise in the world.' Between botched healthcare implementation and one manufactured crisis after another, consumers and small business owners are likely to remain pessimistic, accepting the notion that growth is going to be sub-par and that their government is likely to continue in dysfunctional mode for months to come. "

Business owners are by far and away the best allocators of capital and resources. They understand that higher costs, rising taxes and increased regulations are "bad" for business going forward. This is why almost all part of the small business survey remains at levels normally associated with recessions. The lack of clarity about the future makes it very difficult to commit capital, hire employees and increase production. While the recent report shows some minor improvements in some key areaas it is quite possible the current antics in Washington will squash those "hopes" in the months ahead. The report next month will likely be very telling.

Originally posted at Lance's blog: STA Wealth Management

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