Every day in the business sections of newspapers, we see stories about big businesses. We rarely see stories about small businesses even though they play a major role in the economy. According to the National Federation of Independent Business (“NFIB”), small businesses in the U.S. employ about half of private sector employees, generated approximately 70% of net new jobs annually over the past decade, and created more than half of nonfarm private GDP.
Small Business Conditions Are Weak
Given the impact of small business on the U.S. economy, investors should consider what small business owners are thinking. Luckily, the NFIB gauges their thinking by providing the Small Business Economic Trends survey, which is based on a monthly survey of small businesses. Its August survey, which was based on 730 responses, indicated small business owners are, “refusing to expand; expecting worse business conditions; and unable to fill open positions”. The NFIB’s chief economist added:
The current economic environment is not a good one for strong or sustained growth. – William Dunkelberg, Chief Economist, NFIB
As a result, small businesses are not going out to acquire credit financing. This could prove problematic given credit financing is important to economic growth. After all, when small businesses are borrowing, they are expanding capacity, which leads to greater employment and consumption, which happens to makes up ~70% of GDP. Considering also that small businesses generally respond to changes in economic conditions more rapidly than larger businesses do, investors should always consider what is happening with small business lending.
Small Business Lending Is Declining
The Thomson Reuters/PayNet Small Business Lending Index (“monthly-SBLI”) measures the volume of small business loans issued every month and are based on the most recent data from the largest commercial and industrial lenders in PayNet’s U.S. database, including both loans and leases. PayNet collects real-time loan information from more than 200 leading U.S. lenders. Its proprietary database is updated weekly and encompasses more than 17 million current and historic contracts worth over $740 billion.
As illustrated in the graph above, the monthly-SBLI (green and red bars) declined in 5 of the past 10 months and the rate of decline has worsened. In fact, the most recent data for July shows the monthly-SBLI declined 16% from a year earlier. This was driven by declines in all major industry groups and the 10 biggest states.
Thought the trend is clear, the monthly data is a tad lumpy. To smooth it out, consider it on a quarterly-basis (“quarterly-SBLI”). As you will see, the quarterly-SBLI (black line) in May 2016 experienced negative growth for the first time in six years. It has since worsened given the data from the past three months (May, June, July) shows the quarterly-SBLI declined by 7% from a year ago. As shown in the graph above, the last time the much smoother quarterly-SBLI decreased into negative territory occurred in November 2007. This was only a month before the U.S. economy officially entered the last recession.
Does that mean the U.S. is in a recession? It might be too early to say but it is surely slowing. The slowdown has also been showing up in the data for delinquent loans from the Federal Reserve Board of St. Louis. In fact, PayNet has taken note of this, too. Its data is also showing rising delinquencies. According to PayNet’s President:
The thing that scares us is the rise in delinquencies. Every one of these months where investment is down and delinquencies are up is one step more toward contraction. – William Phelan, President, PayNet
Whether or not you find the SBLI a reliable leading indicator of recessions, please consult an investment fiduciary before making any investment decisions.