Health of US small business: an indicator for the US economy

The NFIB (National Federation of Independent Business) survey can most certainly be considered an important report that monitors the pulse of the US economy.

We recently wrote a blog examining the two components of the non-farm payroll report, outlining the difference between the household and establishment surveys. As part of that discussion, we highlighted the importance of the NFIB survey and suggested that higher interest rates and tighter credit conditions are forcing small firms to tighten their belts.

Fast forward to the current March report, the NFIB Small Business Optimism Index decreased by 0.9% to 88.5, representing the lowest since December 2012, as business owners continue to manage numerous economic headwinds. Unsurprisingly, inflation was recorded as their number one concern.  This overview of what small businesses in the US are worried about gives a good, representative perspective on the strengths and weaknesses of the US economy through the eyes of firms that represent the backbone of the US economy. The “SME” acronym might be less glamorous than the “Magnificent 7”, but small businesses represent circa 50% of the US workforce and they are expressing warranted concerns which are not painting a particularly rosy landscape.

Below are some of the key findings which we would like to highlight from the recent data release:

The net percent of owners who expect real sales to be higher going forward decreased by 8% from February to a net -18% (seasonally-adjusted). 25% of owners reported that inflation was their single most important problem in operating their business (higher input and labour costs), up 2% from February. In line with this, they expect to raise average selling prices, with price hikes most frequent in finance, retail, construction, wholesale, and transportation industries. Profit trends were also mentioned as a concern. Among those reporting lower profits, 29% blamed weaker sales, 17% blamed the rise in the cost of materials, 13% cited usual seasonal change, and 12% cited price change. For owners reporting higher profits, 53% credited this to sales volumes, 23% cited usual seasonal change, and 12% cited higher selling prices.

One of the details we believe we should pay closer attention to can be been found in the recent sharp cooling of planned employment changes. Moves in this measure have broadly led to changes seen in non-farm payroll growth. Although the correlation between the NFIB and the realized non-farm payroll job growth has been strong in recent years, the relationship has also varied a lot over time. Not unlike most data at the moment, caution is needed and it is better to look at a number of indicators before drawing any conclusions.

The report showed that owners’ plans to fill open positions continued to slow, with a seasonally-adjusted net 11% planning to create new jobs in the next three months, down 1% from February and the lowest level since May 2020. Other observations included owners reporting that they could not fill job openings and that the labour quality was a top concern while labour costs decreased slightly. This is important data. The labour market is at the centre of the debate due to its impact on wage and services inflation. We believe that the Federal Reserve (Fed) is aware of the fact that Wall Street and Main Street might be diverging at the moment. This should come up in aggregated data at some stage, given the sheer size of SMEs as a percentage of the economy and employment.

Importantly, while we recognize that the lowest level of net small businesses expecting to increase employment in almost a decade is a worrying signal about future changes in job growth, we also note that the latest print is still solid in a broader historical context. In other words, we see parts of the labour market cooling off from very hot levels which is precisely what the Fed is trying to engineer. In the meantime, we continue to see strong non-farm payroll data with three consecutive months of increases to start the year. But, if signals coming from small businesses are to be noticed, patterns may begin to change. We also know the Fed is data dependant and inflation is still above their optimal target. Wage inflation has been moderating and small business sentiment may just be an important contributing factor in continuing the downward trend seen in wages.