Small Business Doing Better, but Feeling Worse

Small businesses are worried about the future. How worried are they? According to the National Federation of Independent Businesses (.pdf), they reported that sales in April were, on average, the best since December 2007 -- when the recession technically began. But their sentiment still declined. Other factors, especially rising prices, make their prospects look bleak.

Let's start with that sentiment. It declined just a bit in April, according to the NFIB. The firm says that this was really more of an aftershock following last March's plummet in confidence. You can see this from the chart:

In April, sentiment was at its lowest level since September 2010. That's really not good, as the index has shed most of the progress it made during the fall and winter.

As mentioned, this isn't because most firms are actually doing worse, but because they expect to do worse. This chart, which shows actual sales experience for the firms the NFIB surveyed versus their expected sales, sums up this phenomenon pretty well:

Generally, expectations rise when sales improve. You have to go back to May 2010 to find another month where expectations fell when sales improve. And this wasn't just any month for better sales. The sales index rose by the most since April 2010 and was the highest since the recession began in December 2007. Still, expectations worsened. The NFIB also reports that earnings improved in April.

So what's got small business so down? Inflation looks like one major factor. Of the firms surveyed, 8% named inflation as their biggest problem. That might not sound like a lot, but in March -- when inflation was already rapidly rising -- just 5% named inflation as their biggest problem. A year earlier, the statistic was just 4%. Other problems that became more prevalent in April included competition from big business, the cost of labor, and taxes.

Some of these smaller firms are responding to inflation by passing it on to their customers. A net 12% of firms reported higher prices in April. You can see from the chart that prices have been rising quickly over the past couple of months:

This report is a discouraging sign for the recovery for two reasons. You just saw the first one: consumers are facing higher prices. As their purchase power declines, so will their ability to buy as many goods and services. This is a purely mathematical result: if your dollar doesn't go as far, you can't buy as much stuff. And if consumers don't buy as much stuff, then the economy demands less stuff and hiring doesn't need to rise.

But small business' negative sentiment may manage to curb more aggressive hiring on its own. Smaller firms tend to be a major source of job growth in a recovery. Despite recent job gains being better than what we saw in 2010, small business won't contribute many new positions if they do not believe their sales will rise in the future.

If prices stabilize and job gains continue, then perhaps small business sentiment's downward trend will also reverse. From the report, it doesn't look like small businesses are planning on making big changes in employment at this time. If sentiment continues to fall, however, then these companies could begin shedding workers again.