Small Business Investment Spending

The decision to invest in new plants, factories, or even to add new equipment is a function of many variables: Are economic conditions currently solid? What is the

EXHIBIT 6.3 NFIB Hiring Plans Index versus Unemployment Rate

outlook for growth? Is it expected to advance at a solid pace in the next couple of months or years, or are there disconcerting issues looming? Will there be enough business coming through the door to justify my capital expenditures? Are interest rates at appropriate levels? Do I really need to make such a large investment? These are just a few of the dozens of questions business owners must ask themselves prior to committing funds to these particular projects.

In order for a businessperson to invest, they had better have the right responses to these and several other questions. They must also be assured of their expectations. Only when they are confident that their actions will give a desirable return on their investment will they move forward and commit those funds. That is why Capital Expenditures Plans is such a wonderful indicator. If the outlook is bleak or less than positive, then businesses will not invest. If expectations are bright, an upbeat assessment should be projected, especially for business equipment and services spending.

In Exhibit 6.4, we compare the NFIB’s Small Businesses Capital Expenditure Plans Index against the year-over-year change in U.S. nonresidential fixed investment, and one of its major sub-components, business equipment spending. There is obviously a solid correlation, especially when economic conditions flourish as they did from 2002 through 2006. In 2007, the Index began to slide, and investment measures followed in time.

The two series diverge in early 2009, as capital spending in the U.S. escalated and small business intentions to invest remained at or below those levels traditionally associated with recession. This had a great deal to do with the ability to access funds.

Financing is crucial to the proper functioning of trade and commerce for any company, but more so for those in the small business sector. Large, multinational publicly traded corporations like Macy’s, Coca-Cola, and Wal-Mart have easier access to the capital markets. They can issue equity-backed securities or long-term debt. Small businesses don’t have that luxury.

And since the credit crisis of 2007—2009, many small firms have suffered from the inability to borrow. Anecdotal reports of small retailers financing operations and inventories using personal credit cards—amid lofty interest rates— were commonplace.

Unfortunately, it appears as if enacted policies had little influence on the small business community. In the Monetary Policy Report of February 26, 2013, the Federal Reserve noted, “Borrowing conditions for small businesses continued to improve over the second half of 2012, but as has been the case in recent years, the improvement was more gradual than for larger firms. Moreover, the demand for credit from small firms apparently remained subdued.” This might be either a function of banks unwilling to lend to an historically riskier, less solid borrower, or smaller businesses not willing to take on debt that might not be able to be repaid.

EXHIBIT 6.4 NFIB Small Businesses Capital Expenditure Plans Index versus Non-residential Fixed Investment

A similar measure to the Capital Expenditures Index is the NFIB’s Good Time to Invest Index (Exhibit 6.5). Knowing whether conditions and underlying economic fundamentals are conducive to expansion is critical for those studying the overall pace of economic activity, or determining the state of affairs for new business formation and start-ups. This has always been a favorite indicator. What could be more telling than the confidence level that the economic drivers of the economy, small businesses, have regarding the desire to expand their businesses.

Since this series has an expectations element, it assumes a bit of a leading quality. In fact, prior to each of the last two recessions, the Good Time to Expand Index fell, on average, 12 months before the initial downturn in the economy. The warning signal in this series seems to be flashed when the Index hits 14.0.

Readings below 14.0 are often associated with troubling times for the small business sector and, unsurprisingly, the overall macroeconomy. The year-over-year growth rate in real GDP is about 2.0 percent when the Good Time to Expand Index approaches 15.0, which is often a recession signal. With one exception since 1948, when the four-quarter change in real GDP slips below 2.0 percent, the economy eventually has fallen into recession.

In 2003, the Index plunged to 7 yet no recession ensued. Many economists on the Street had expected a so-called double-dip recession since many indicators had fallen to levels traditionally associated with an economic downturn.

In early 2007, the Good Time to Expand Index fell from 18.0 to 12.0, then nine months later, the U.S. economy entered depression.

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