As pessimism about consumer demand grows, hiring may halt

The American job growth engine appears to be sputtering. Small business optimism fell in May for the third straight month, according to the National Federation of Independent Businesses. Its detailed monthly report shows that falling sales and rising prices are driving pessimism among small business owners. The result could be disastrous for hiring.

Optimism Falls

Let's start with the NFIB's Small Business Optimism Index, which provides a broad measure of economic sentiment among these companies:

Although it only fell by 0.3% in May, you can see the steady decline. To be sure, this isn't the direction we want to be seeing small business sentiment heading in a recovery.

Sales Struggle

Weak sales served as one big reason that these companies aren't feeling felling so good about their prospects. Here's a chart showing actual sales and expectations:

More NFIB's survey respondents reported lower sales in May. Worse, the fewest net respondents reported higher sales expectations since October. As a result, many of these small businesses are cutting their inventories.

Prices Climb

Rising prices present another obstacle for these companies. Check out how the net percent of these firms reporting higher prices has grown just this year:

That's a pretty steep ascent since January. We haven't seen such a high net percent reporting that they've increased their prices since October 2008. Some of those commodity price increases we've been seeing must be translating into higher inflation for other goods and services. This poses a problem for overall sales, which will decline as consumers face more expensive products.

Hiring Halts?

The most important problem that small businesses identified in May was poor sales. But the biggest year-over-year gainer was inflation. Last month, 10% of firms named inflation their most important problem, while just 4% named it most important a year earlier.

As pessimism rises, sales fall, and prices increase, we can expect to see hiring slow. In fact, hiring plans in May actually turned negative, according to the NFIB:

May's result is terrible here. It shows that for the fist time since September 2010, and for just the second since April 2010, one net percent of small business respondents say they are not hiring. Looking at the chart, you can see that for much of 2008 and 2009 -- when most of the layoffs occurred during the recession -- this statistic wasn't that much worse than it was in May.

Seeing hiring plans sour to this extent is a particularly startling result in the context of small businesses. They often lead the way back to full employment after a recession, since their growth potential is often much stronger than that of big business. If they aren't hiring, then we can expect job growth to be pretty small to nonexistent.

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