US Small Businesses Face Big Problems

Last week, markets were treated to the worst read on NFIB small business optimism since April of 2020.

That was notable for two very obvious reasons. First, it suggested the mood among small employers in the world’s largest economy is barely better than it was when an engineered economic coma pushed tens of thousands of “mom-and-pop” businesses to the brink of extinction.

Second, small businesses account for nearly half of all private sector employment in the US, so when they’re feeling down on their luck, it can be both a cause and a consequence of concurrent developments in the jobs market.

Read more: Small Business Optimism Sinks. Outlook Worst Ever

Currently, employers are bedeviled by rising costs and labor shortages. I’m a broken record when it comes to assessing this situation. I’ll recycle some familiar language.

Small businesses aren’t able to cope as well with margin pressure as large corporates. S&P 500 margins came into Q1 earnings season loitering near record highs. Wall Street will demand clarity on earnings calls — management will be compelled to explain exactly how they intend to protect bottom lines in the face of gale-force headwinds. But it’s not an existential issue for giant multinationals, whose capacity to preserve profitability despite sundry threats is essentially unlimited compared to small businesses, for whom the current macro environment could be a financial death sentence.

With that in mind, I wanted to highlight the figure (below) derived in part from the NFIB survey. It’s simple enough, but as SocGen’s Jitesh Kumar and Vincent Cassot suggested, it appears to presage an egregious performance disparity. “Combined inflation and labor market concerns rose to new all-time-high levels point[ing] to a continued underperformance of small-cap stocks versus large cap stocks,” they said.

If you’re bullish on small-caps, that rather poignant visual may be cause to reconsider, or at least to take a step back.

Kumar and Cassot discussed the same dynamic in their latest vol outlook, and in the process made an important distinction when it comes to purportedly healthy corporate debt ratios.

“Corporations have raised a significant amount in liquid assets, which are approaching their highest levels, both relative to US GDP and their liabilities,” they said late last month. The figure (below) shows the latter relationship.

Underscoring points made here last week (and reiterated above), SocGen noted that “most of this cash sits [with] large and mega cap stocks and the smaller firms are having to compete for labor against larger firms with much bigger budgets.”

This is another manifestation of “Wall Street versus Main Street” and as such, there’s a parallel with family budgets. Analysts reluctant to countenance a US recession any time in the next 12 months point to healthy corporate balance sheets and make similar arguments for households. There’s merit to such contentions, and yet, as noted in “Is A US Recession ‘More Fear Than Fact’?“, the majority of household wealth and remaining cash buffers are concentrated in the hands of the wealthiest Americans, who have the lowest marginal propensity to consume. Similarly, it’s reasonable to suggest that large corporates (and especially those with ready access to capital markets) control the vast majority of liquid assets.

But, again, small businesses account for half of all private sector employment in the US. Just as we need Main Street to spend, we need Main Street to hire. If small businesses can’t compete for workers in an environment of surging labor costs, corporate America will need to compensate for lost hiring once mom and pop are tapped out.

Currently, there’s an acute shortage of labor, so this shouldn’t be an issue. One wonders, though, what might happen in the event management teams at large corporates tire of incessant margin pressure and decide instead to accelerate automation, or take other steps to reduce the need for carbon-based workers.

I suppose the supply of available human labor would then increase, pushing down labor costs, but if small businesses have already closed the doors by then, it won’t matter.