Economic Perspectives

Steve Scranton
SVP, Chief Investment Officer and Economist

Economic Update

Inflation data was the focus of economists and financial market participants this week.

Inflation

• The Bureau of Labor Statistics (BLS) reported a slowing in the pace of inflation. The Consumer Price Index (CPI) rose 0.3% for the month of April compared to a 1.2% increase in March. CPI rose 8.3% in April compared to 8.5% in March.
• The BLS also reported slowing in wholesale inflation. The Producer Price Index (PPI) rose 0.5% compared to a 1.6% rise in March. On a year-over-year basis, PPI rose 9.2% after rising 9.6% in March

Employment

• The Department of Labor reported a small increase in filings for initial unemployment benefits. Initial jobless claims rose 1,000 to 203,000 as of May 7^th. Total continuing claims fell 44,000 to 1,343,000. This is a sign that long-term unemployed are reaching the end of their eligibility for benefits.

Manufacturing

• The Census Bureau reported an increase in wholesale inventories for March. Wholesale inventories rose 2.3% in March which matched the 2.3% increase in February.

Small Business

• The NFIB released the results of its small business optimism survey. The index was unchanged in April compared to March with a reading of 93.2. Today’s Perspectives section discussed this data in more detail.

Perspectives

For anyone who has visited castles or read about them, you know that most castles were set up with a two layer defense system. They had the outer wall as the first layer of protection for the castle owner and then an inner wall as the second layer. To me, small businesses are the outer wall for the economy and consumers are the inner wall. For most “Main Street” American cities, small businesses are the engine for jobs growth that supports and fuels economic growth. They are what help protect the economy from recession. If small businesses come under pressure due to a variety of factors including, but not limited to, supply and labor shortages, high prices or wages, reduced sales or increased competition, their profitability falls or evaporates. As this line of defense starts to deteriorate, consumers are then coming under increasing pressure. Needless to say, the two are entwined.

For the past month I have provided perspective on the “inner wall” (consumer) in the current economic environment. Today I want to focus on the “outer wall” (small business). With the current Small Business Optimism report from the NFIB released this week, I think it is an appropriate time to revisit the world of small businesses.

The NFIB surveys its constituents each month to “take the pulse” of small businesses in a variety of categories. Its survey focuses primarily on whether the categories surveyed have improved or deteriorated. It is not designed to be a quantitative survey that lets us know what levels exist (amount of sales, number of jobs added, etc.)

Observations

General

• Like the consumer, inflation has become the most important problem for small businesses with 32% listing it as their single most important problem. According to the NFIB, this is the highest reading since the 4^th quarter of 1980. For perspective, the official inflation rate was 12.50% at that time.
• It is concerning to see that the outlook for general business conditions is at -50%. Since this number is the difference between those with a positive outlook versus those with a negative outlook, this means that 75% have a negative outlook for general business conditions over the next six months while 25% have a positive outlook (resulting in a net negative of -50%). The NFIB reports that this is the lowest level recorded in the 48 year history of the survey.

Labor

• One of the concerns for small business owners is the reality that they are usually “price takers” versus “price makers”. What that means is that small businesses often don’t control the pricing for the products if they have competition from bigger firms. They have to take the pricing implemented by their big business competition. It is the bigger firm that sets the price. This includes the price of labor. An example is if McDonald’s or Target raises their wages, small business restaurants and retail stores may have no choice but to raise their wages in order to retain their employees. The good news from the survey results is that this is not currently a problem. No one — 0% — listed competition from big business as the single most important problem. The problem for small businesses when it comes to labor is a lack of qualified help. The second highest response (after inflation) to the question regarding the single most important problem was lack of qualified help.
• Almost 50% of small business owners reported having job openings that they cannot fill and 55% reported a problem with finding qualified help. Anecdotally, I continue to be shocked when I read stories of companies reporting employees never showing up for work after being hired.

Earnings

• The earnings trend for small businesses has not improved. It is still a net negative where 58.5% report lower earnings over the past 3 months while 42.5% reported higher earnings. This is the 4^th straight month with these percentages and 7 out of the last 8 months at this level.
• Actual sales and expected sales showed minor improvement but are still at low levels.

Prices

• There is a possible sign that rising prices may be peaking. Both actual prices paid and plans for raising prices dropped from the historic highs of March.

Compensation

• Both actual compensation paid and plans for increasing compensation also dropped slightly compared to March. This may help explain why cost of labor was not a high ranking problem in the survey results.

Capital Investment

• If small businesses are going to continue to face labor shortages, then investments in plant & equipment as well as technology will be needed in order to maintain or improve productivity. Unfortunately, capital expenditures declined slightly in March and have not changed much over the past 18 months. The good news is that capital spending is a net positive which means small businesses are making capital expenditures; they are just not increasing the level of spending. The encouraging news is that the capital expenditures that were made were focused primarily on equipment.
• Plans to increase capital spending did increase slightly in April, but on a longer time horizon continue in the same range that has existed since the economy started to reopen.

Summary

• Even though the composite sentiment index was unchanged from last month, the underlying data continues to show that challenges remain for small businesses.
• There is often a difference between how you feel (i.e., confidence) and what you do. We will need to monitor closely whether small business owners change their behavior based on their historically low outlook for the economy over the next six months.
• Inflation (or is it really the high level of prices?) is just as much a concern for small businesses as it is for consumers.
• Labor may prove to be the real headwind to growth for small businesses. It is hard to increase production and sales if you don’t have people to do the job.

Conclusion

• The data from the NFIB shows an environment where small businesses are facing challenges.
• The data does not show evidence of the “outer wall” collapsing and the economy heading for a recession. The data shows more a picture of an economy that is slowing but still growing.
• Pay attention to — and support — your local small businesses. Changes in operations including, but not limited to, shortening business hours, more frequent sales specials, and fewer employees in the store, may be a leading indicator of changes happening in your local economy. Of course, the same applies if you see the opposite happening which would be a sign of economic strength.
• It may seem like a small thing, but many of us probably don’t recognize the challenge that may be happening behind the scenes for some (many?) of our small business owners. Here is a thought: try a Random Act of Kindness by thanking one of the small business owners where you shop for the contribution that they make to your local economy. You may be amazed how a seemingly small act like that may provide huge moral support to the business owner.

Even though spring seems to be stubborn about arriving, I will be on vacation next week practicing what I preach regarding small businesses. I will be on a bicycle ride — with my son — across the state of Washington (Puyallup to Spokane) via the multiple trails that exist. We will be supporting the local leisure and hospitality industry as we go because I am too old for “roughing it” by camping. Hopefully, we won’t utilize any of the local medical facilities!

Enjoy your weekend.

DATA TABLES

Description of Survey Components:

Outlook for Expansion

• Percent who believe it is a good time to expand over the next three months

Outlook for General Business Conditions

• Percent who believe that general business conditions will improve over the next six months minus percent who believe it will get worse

Earnings Changes

• Percent who experienced higher earnings over the last three months compared to the previous three months minus percent who experienced lower earnings

Sales Changes

• Percent who experienced higher sales over the last three months compared to the previous three months minus percent who experienced lower sales

Sales Expectations

• Percent who expect sales to be higher over the next three months minus percent who expect sales to be lower

Price Changes

• Percent who raised prices over the last three months compared to the previous three months minus percent who lowered prices

Price Plans

• Percent who plan to raise prices over the next three months minus percent who plan to lower prices

Employment Changes

• Percent who increased employment over the past three months minus percent who decreased employment

Lack of Qualified Job Applicants

• Percent who found few or no qualified applicants

Job Openings

• Percent with positions open that they are unable to fill at this time

Hiring Plans

• Percent with plans to increase hiring over the next three months minus percent planning to decrease hiring

Compensation Changes

• Percent who increased compensation over the last three months minus percent who decreased compensation

Compensation Plans

• Percent with plans to increase compensation over the past three months minus percent planning to decrease compensation

Regular Borrowers

• Percent borrowing at least once every three months

Availability of Loans

• Percent who found it easier to obtain a loan compared to three months ago minus percent who found it harder

Borrowing Needs Satisfied

• Percent of all business satisfied their borrowing needs were met/percent who are not satisfied

Expect Easier Credit Conditions

• Percent who believe credit conditions will be easier over next three months minus percent who believe it will be harder

Relative Interest Rate Paid

• Percent who paid a higher rate compared to three months ago minus percent who paid a lower rate

Actual Interest Rate Paid

• Average interest rate paid on short-term loans

Inventory Changes

• Percent who increased inventory over the past three months minus percent who decreased inventory

Current Inventory

• Percent who believe their inventory is too low minus percent who believe it is too large

Inventory Plan

• Percent who plan to increase inventory over the next three to six months minus percent who plan to decrease inventory

Capital Expenditures

• Percent who made capital expenditures over the last six months

Capital Expenditure Plans

• Percent planning to make capital expenditure over the next three to six months

Source: NFIB

“High” is the highest level over the past 5 years

“Low” is the lowest level over the past 5 years

Single Most Important Problem

Most Important Reason For Expansion Outlook

Most Important Reason For Lower Earning

Type of Capital Expenditures Made

Amount of Capital Expenditures Made