Small Business Pessimism Increases

Nobody has to tell you that costs are up. You've probably seen the effect in your bottom line. Does this cause you to have a pessimistic outlook about the second half of the year? You're not alone. Pessimism is on the rise among the nation´s small-business owners who, in June, confirmed their views that a slowdown is coming in the second half of the year. Sales-growth expectations declined dramatically. In addition, weaker job-creation plans, declining inventory purchases and fading expansion hopes peeled 1.8 points off the NFIB Small-Business Optimism Index, which settled at 96.7 (1986=100) for the month.

"Although June´s sales, profit gains and capital spending plans were as solid as May´s, that month wasn't very strong," said NFIB Chief Economist William Dunkelberg. "Taking a realistic view of the easing economy, owners are scaling back plans to spend and hire."

A sharp seven-point decline to 13 percent in the net-share of owners expecting higher real sales triggered a net drop to zero of those planning to increase inventories. This is down three points from May and consistent with views of slowing sales in the second half of 2006. Actual inventory-increase reports were flat. A net-negative 1 percent reported stocks too low, unchanged from May and a very lean position.

Higher actual sales in the most recent three months were reported by a net 6 percent, historically strong but five points below May´s numbers. Seasonally unadjusted, slightly more than one-third claimed higher sales while 23 percent reported the opposite.

Job-creation plans over the next three months fell 11 points to 15 percent in June, and 5 percent of owners are forecasting workforce reductions, yielding a net 9 percent of owners planning to create new jobs, a five-point drop from May´s figures.

Seasonally adjusted, 10 percent of the owners reported increasing employment in June an average of 3.3 workers per firm, but 12 percent cut an average 1.7 workers. Slightly more than half hired or tried to hire one or more workers, a little slower than May. Eighty-eight percent of those reported few or no qualified applicants for open positions, an indication of a tight labor market.

One fourth had unfilled job openings, unchanged from May and historically high, another sign that labor markets are tight. Twelve percent reported that the availability of qualified labor remained their top business problem.

Projected spending on new capital equipment is now at its lowest point since early 2003, down five points from May. Although the share of those expecting conditions to improve over the next six months rose two points, it´s still in negative territory at a net-negative 8 percent. Those expecting improvement in real-sales volumes dipped seven points to 13 percent, the second-lowest reading since early 2003. Profit trends and reports of sales gains remained historically high, but owners have less confidence that strong growth can continue.

Capital spending, overall, faded. The frequency of reported capital outlays over the past six months fell two points to 60 percent of all firms. Forty-three percent reported spending on new equipment, 22 percent acquired vehicles, 16 percent bought new fixtures and furniture, 13 percent improved or expanded their facilities and 6 percent acquired new buildings or land for expansion.

After losing five points in May, capital-spending plans over the next few months lost another point, falling to 27 percent, consistent with a dimming view of growth in the second half of the year.

Although good news for the Federal Reserve´s inflation-fighting efforts, the decline in the net percent of firms raising average selling prices fell two points to 23 percent, seasonally-adjusted. But the bad news is that the level of firms still raising prices remains high at 34 percent, unadjusted.

While also boding well for inflation worries, the percent of owners reporting lower selling prices rose to 12 percent, but price pressures are still too strong. The incidence of reported hikes remains inconsistent with core inflation. Price increases in the service sectors remained muted, especially in finance, insurance and real estate, but hikes in construction and manufacturing held firm.

Good news for profits appeared in June. Positive earnings trends were similar to May´s. Sales gains were solid — as many firms raised selling prices as reported higher compensation costs: 23 percent and 22 percent, respectively.

Of the 24 percent reporting higher earnings, half cited stronger sales — down 14 percentage points from May — and 13 percent credited higher selling prices; 4 percent each named lower materials costs, lower taxes and regulatory costs. For the slightly more than one-third reporting lower earnings, 29 percent cited weaker sales, 18 percent noted higher materials costs — mainly energy — 15 percent blamed lower selling prices, and 6 percent each pointed to higher labor costs, higher taxes and higher regulatory costs.

Borrowing is on the rise. Regular activity was reported by more than two-fifths, up three points from May and near monthly-survey peaks. The net-percent reporting loans harder to get in recent months was unchanged at a net 5 percent. Only 5 percent cited the cost and availability of credit as their key business problem. This reading is far from the record of 37 percent reached in 1982, but trending up from recent low levels.

Dunkelberg said, "Small-business owners appear to expect little change in credit availability, which is far more important to them than the cost of credit."