The National Federation of Independent Business (NFIB) released its Small Business Optimism US Index today indicating it has decreased to 91.2 in August.  This breaks the improving trend since dropping to a multi-year low in March.

Key findings in the report include:

• Twenty-four percent of owners reported inflation as their single most important problem in operating their business, down one point from July.

• A seasonally adjusted net 20% plan to raise compensation in the next three months, up two points from July.

• The net percent of owners raising average selling prices fell two points from July to a net 20% seasonally adjusted.

• As reported in NFIB’s monthly jobs report, a seasonally adjusted 40% of all small business owners reported job openings they could not fill in their current period, up two points from July. Of the 62% of owners hiring or trying to hire in August, 90% reported few or no qualified applicants for the positions they were trying to fill.

• Fifty-six percent of owners reported capital outlays in the last six months, up two points from July. Of those making expenditures, 40% reported spending on new equipment, 21% acquired vehicles, and 18% improved or expanded facilities. Eleven percent spent money on new fixtures and furniture and 5% acquired new buildings or land for expansion. Twenty-four percent (seasonally adjusted) plan capital outlays in the next six months, up one point from July.

• Three percent of owners reported that all their borrowing needs were not satisfied. Twenty-six percent reported all credit needs met and 60% said they were not interested in a loan.

Based on the survey, many small business owners continue to struggle to find qualified employees.  Navigating inflation is a challenge and many plan to raise their own prices.  NFIB reported that 33% report raising compensation, and a net 20% plan to raise compensation in the next 90 days. Twenty-one percent said that labor quality was their top business problem behind inflation as their number one issue.

The optimism index has remained below its 50-year average for the past 32 consecutive months.  One would conclude that since small business owners are pessimistic about their future, the S&P 600, a small-cap index, would therefore be underperforming to the mid-cap S&P 400 and the S&P 500 large-cap index.  The conclusion would be correct. 

At the start of the pandemic in early 2020, investors aggressively sold their stock holdings, especially the small and mid-sized companies.  The S&P 500 and NASDAQ Indices recovered faster than the S&P 400 (mid-sized companies) and S&P 600 (small-sized companies) in 2020 and have provided superior returns to this day. The Federal Reserve rate hike campaign from 2022 to March 2023 prompted investors to reduce stock allocations bringing down all major indices in 2022. However, in October 2022, investors returned to the stock market with a focus on large companies, especially in the tech sector.  Since 2020, the S&P 500 and NASDAQ have outperformed the S&P 400 and S&P 600 by more than 90%.  Below are the cumulative gains of the four major indices since 2020:

• S&P 500: +70.10%

• NASDAQ: +89.75%

• S&P 400: +42.89%

• S&P 600: +30.34%

This is not the first long stretch of time that small business owners have been pessimistic.  In March 2007 the index dropped below 98 for the first time in four years and did not recover until November 2016, a consecutive streak of 117 months with the index below 98.  

During this same period, the S&P 600 outperformed the S&P 500 by almost 50%.  Even though the NFIB Small Business Optimism index was at the same levels as today, it did not provide investors insight on how to invest.  One would have thought with the low levels of the NFIB index that the comparative S&P 600 would also be underperforming as it has these past three years.  Small business owners were just as pessimistic as they are now, but the stock returns of small and mid-sized companies were significantly better. The lesson learned is that investors need to research several data points before drawing conclusions on an investment strategy. 

We have discussed in this Weekly Update the importance of staying current with your portfolio.  Seasons change in nearly every aspect of life including the weather, home decorations, skirt hemlines, and clothing styles.  Missing market rotation from one category to another can cause underperformance or worse losses.  By October 2023, nearly three years after the start of the pandemic, the S&P 600 had a cumulative return of 5.41% vs NASDAQ 42.89%.  Missing this rotation from small stocks to large and technology stocks resulted in investment returns of a dismal 2% annual return.

What Does This Mean to Me?

If history is an indicator of the future, investors should be watching for indications of when both the S&P 500 and NASDAQ will start to underperform and trailing the small and mid-cap indices.  Currently, the advantage is with larger companies with significant cash war chests and market penetration.  However, during the past 30+ years, I have been managing investment portfolios, I have seen growth opportunities switch from various industries and company sizes.  Institutional investors are keen on these changes and monitoring how they rotate their portfolios between sectors and company size provides insights into potential new trends.  Paying attention to market changes is critical to avoid account underperformance and more importantly, losses as current leaders become the new losers. 

For now, NFIB is indicating that small business owners remain pessimistic about their future and the significant underperformance of the S&P 600 would confirm their challenges are impacting profits.  Earnings and growth continue on a positive trend especially for many of the top stock-performing companies based on recent earnings and forecast reports.  One investment component of our investment methodology is determining the pace of momentum for the US economy, stock markets, and industries.  We will begin to underweight or remove specific securities when their momentum begins to wane.  A good recent example of a reversal of a former strong sector is the residential real estate market.  The entire residential real estate sector trend came to an abrupt halt when the Federal Reserve initiated its rate hike campaign.  Buying homes for most people became unaffordable with mortgage interest rates doubling in less than 24 months and the volume of sales dropped dramatically.  However, it is only a matter of time before this cycle will also reverse, and buying activity and profits will return to the real estate market.

Let us know your thoughts on this Weekly Update.  Also, give us a call or send an email if you have any questions about your own financial situation and how we may be able to help you and your family.