04/ 02/ 2008
by Bill Dunkelberg
The Index of Small Business Optimism fell in January to the lowest reading since January 1991—when the country was in a recession. If confirmed by surveys later in the first quarter, the index is signaling the start of a recessionary period starting in the second quarter.
Doing the Math
When the numbers are in, first-quarter growth is expected to be weak, on the low side of 2 percent but better than the fourth quarter of 2007. Here's why: The government's first guess at fourth-quarter GDP showed little growth, only 0.6 percent at an annual rate. But the reduction in business inventories took 1.3 percentage points off of the growth rate. So, spending was actually up 1.9 percent (0.6 + 1.3), but sales were supported by reducing inventories, not ordering new goods. That offered bad news for 2007, but it's good news for 2008 as firms are more likely to order new goods and materials to replace inventory. This will add to first-quarter GDP.
Government spending was up just 0.3 percent (and defense spending was reported lower). This will be reversed significantly in the first quarter, restoring government spending (20 percent of GDP) to a 3 percent or better growth rate. New construction fell 24 percent, but commercial construction grew 16 percent. So, including inventory reductions, investment spending overall was off 10 percent at an annual rate. If new home construction falls by less than 24 percent and commercial construction continues at fourth-quarter rates, this will add to GDP numbers.
New exports added 0.4 percentage points to the growth rate and will do so again. Thus, the math accounting for our growth in GDP indicates soft growth in the first quarter, but much better than the fourth, though under 2 percent (unless consumers, 70 percent of GDP, really pull back in the first quarter). So, first-quarter growth looks to be slow (as predicted by the October NFIB Index reading), but could go negative in the second quarter if the January index reading is confirmed in later surveys.
Measuring Mood
Fifty-one percent of the decline in owner optimism came from three Index factors: expected business conditions in six months, expected real sales and the environment for expansion—all “mood” measures. Since September, the expectations components have accounted for two-thirds of the decline in optimism, with expected business conditions alone accounting for a third of the decline. Thus, we have a “recession in expectations” more than in the real components of the Index. All the economic news seems to focus on stocks and banks, not on the bread-and-butter businesses that produce half of private sector GDP.
The Fed Effects
It is clear that the surprise Fed moves have caused small business owners to pull back on hiring and spending, contributing to the decline in economic activity experienced in the fourth quarter, which is likely to continue in the first quarter of 2008. Each cut has produced a major reduction in optimism, including hiring, and capital and inventory investment. For example, in early September, 24 percent of business owners expected the economy to improve over the next six months (net of those expecting a slowdown). In the 12 days following the Fed surprise rate cut and warning about recession, the net percent expecting a better economy fell to 5 percent. The Fed is one talking head that business owners listen to.
But of course the economy was going to slow down in the fourth quarter. The 4.9 percent growth rate could not be sustained (long-run growth trend is about 3 percent). And credit would certainly be tightened after lenders practically gave away mortgages in most of 2007. In addition, Washington's economic policy and media coverage have induced consumers and business owners to cut back, contributing to the slowing that the economy has experienced. Let's hope we haven't talked ourselves into a recession.
This article is from the April/May 2008 issue of MyBusiness.
