Over the course of the current economic cycle I have written numerous times about the theme of “the tale of two economies.” In short, large companies have enjoyed a vigorous recovery, record profit margins and all time high nominal profits. But their US domestic small business brethren have seen nothing of the sort. In fact, small business optimism even today stands at a level that is more reminiscent of historical recession lows, let alone anything bordering on recovery.
In last month’s NFIB small business optimism report, we saw the general level of optimism reach a number it has not seen since 2008. But before getting too excited, it’s a level barely above the highs of last year. Personally, I have long contended that confidence surveys leave a good bit to be desired in terms of being meaningful leading indicators in and of themselves. In my book, confidence is expressed in spending, plain and simple. In the macro, large companies have done well in good part because of global government stimulus that in essence became spending. Let’s face it, the local small business down the Street could not even feel the enormity of Chinese stimulus spending from 2009 to 2011, but Caterpillar sure could. Hence the tale of two economies theme.
The chart below is the headline ISM index on top of the NFIB survey component that measures forward small business capital spending plans.
To me, what this chart represents is the “tale of two economies” as embodied this time in capital spending data. You know that it’s the very large US manufacturers who make up the ISM survey, not the local sheet metal shop down the road. Without question, small businesses have been extremely cautious in the current cycle regarding spending. Is there pent up demand for capex at the small business level? There sure as heck should be after nearly four years of drought, so this is the number to watch to see if 1) small businesses really are recovering, 2) the macro US economic recovery is broadening out or 3) whether small business capital spending can make up for some of the slack in larger macro capex driven by slowing in Europe and China. In other words, it’s time to sweat the small (business) stuff.
It terms of large company versus small company fundamentals, over the very short term the tables have now turned a bit. With Europe (China’s largest trading partner, by the way) down for the count and China very much slowing, now it’s the larger multi-nationals that may feel the capex spending pinch. I will not drag you through yet another chart, but you know durable goods orders (capital spending) have been a bit weak as of late and the year over year growth rate is declining in terms of rate of change, even ex aircraft and defense spending. As mentioned above, capital spending on the part of small business has been almost non-existent in the current cycle. It’s now or never and this is the number we need to watch to see if the domestic US economy can go the extra mile as the globe slows. If the US is to “muddle through”, small business capex acceleration could be a key piece of the equation.
The chart below tracks small business capital spending plans (current level marked by the black dotted line) as well as small business perceptions of credit availability.
A number of folks have argued that in the current cycle, small business access to credit has been tough. This being one of the reasons small businesses have had quite the difficult go of it. As you can see above, small business perceptions of credit availability have followed cap spending plans historically, with credit availability now at a new cycle high. But as we listen to what small businesses say in their qualitative review, credit availability does not seem to be an issue. From the latest report:
“Financing remained low on the list of concerns for business owners. Only 3 percent cited financing as their top business problem. Ninety-two (92) percent reported that all their credit needs were met or that they were not interested in borrowing.”
This definitely makes the story a bit more interesting, no? Despite claims of credit tightness causing a small business capital expenditure drought, survey respondents themselves tell us credit availability is either easy or they literally do not want/need to borrow. What has been and continues to be the number one concern of small business is sales. Let’s face it, just what finances small business capital spending anyway? That’s right, sales. So where are we? The combo chart below shows us small business 3 month forward pricing plans and sales expectations. Interestingly, small businesses expect to increase prices, but expect the rate of change in sales to fall.
To be honest, this deserves just a bit of a closer look. So the final chart below documents small business sales and pricing expectations since 2009.
As you can see, as the cycle started in 2009, small business expectations for sales recovered a lot more quickly than expectations for rising prices. To be honest, simple common sense. Sales strength begets pricing strength. If this is not economics 101, then I don’t know what is. But this relationship started to change last year. As price expectations climbed from early 2011 through the first quarter, sales expectations began to soften. After the decline in pricing expectations (2Q –3Q 2011), expectations for sales recovered strongly. And now once again we see the inverse of the historically aligned relationships in the current year – price expectations up and sales expectations down.
Question: Are small business sales expectations being driven by perceptions of inflationary/pricing pressures? I’ve asked this question many a time regarding small businesses – is their outlook for higher prices due to sales optimism, or are they being forced to raise prices to maintain margins/profitability. Believe me, I wish I knew the definitive answer to these questions.
And that brings me back to capital spending. Again, if small business fundamental prospects are getting better, there is the chance that small business capital spending will pick up the slack for the slowing in larger company capital outlays. Great for the US economy in terms of muddling through a period of macro global slowing. But that’s going to mean sales need to perk up. The data suggest “pricing power” is reactive as opposed to proactive (responding to higher sales) for the small business crowd. THE measure of confidence at the business level is the willingness to commit capital. Stay tuned in the months ahead and look at the small business capex trends. They could indeed be quite the tell for the broader domestic economy.
