By now, you’ve no doubt heard about the optimism gap between gloomy small business owners and buoyant investors. To some, it’s as wide as the late 1960s generation gap over the Vietnam War, or even today’s generation gap over gay marriage. But however yawning the optimism gap happens to be, there are logical reasons for it.
The rising stock market certainly reflects investor sentiment, as the Dow Jones Industrial Average has soared past the rarefied air of 14,800 points before the bombing in Boston. By mid April, the Dow, the Standard & Poor’s 500, and the Russell 2000 all had experienced solid growth since the beginning of 2013, and barring another unforeseen event, that’s likely to continue.
Most credit an accommodating monetary policy in which the Federal Reserve Board purchases $85 billion in Treasury and mortgage-backed securities each month, and there’s the usual reason the stock market surges – strong corporate earnings, which have set records for some industrial giants. While the Fed is divided on how long to maintain the current pace of bond-buying stimulus, Chairman Ben Bernanke has said low interest rates will continue to support the recovery even after the Fed stops buying bonds.
Meanwhile, the nation’s small business sector, which produces half the private gross domestic product and employs half the workforce, continues to sputter. The latest Commerce Department data show the U.S. economy grew at an annual rate of 0.4% in the October-December quarter, which was better than the previous estimate of 0.1% but nowhere near robust. Preliminary data for the first quarter of 2013 were expected to top that, but then a disappointing March jobs report tamped down those expectations.
Nationally, the sentiment of small business owners has been volatile. Their pessimism reached a new low right after the presidential election, as the Wells Fargo/Gallup Small Business Index plunged to -11 in November, the most pessimistic level in two years. But they began to rally at the start of the year, when the index rose to +9, and they felt more positive about their own revenue prospects and their plans for capital spending.
Then came a jobs roller coaster, with a healthy 236,000 net new jobs, including 246,000 in the private sector, created in February, but only 88,000 in March, when nearly 500,000 people left the civilian workforce by either quitting their jobs, withdrawing from the job hunt, going back to school, or simply retiring. Which monthly snapshot is more indicative of the labor market’s condition – February’s strong performance or March’s body blow – is anyone’s guess.
While it’s always dangerous to put too much stock in one month’s data, the March employment report was aligned with the souring mood of small business owners. After three consecutive modest gains, the March Index of Small Business Optimism, published by the National Federation of Independent Business, declined 1.3 points.
At the state level, Wisconsin ranks only 44th out of the 50 states in private-sector job creation, according to government jobs data that cover the 12 months from September 2011 to September 2012. The state, with only 0.9% private-sector jobs growth in that 12-month period, trailed all of its Midwestern neighbors; the region was led by Indiana, which experienced a 2.2% increase in jobs growth in that same period.
In this look at the state of the economy, IB explores whether there is a chance for greater alignment in the respective outlooks of Wall Street and Main Street, or whether we’re simply stuck in a slow-growth pattern with no end in sight.
Two sides of the coin
The easy explanation for the optimism gap is that the stock market’s performance is largely based on corporate earnings, which have remained impressive in Wisconsin and beyond, while small businesses rely heavily on the purchasing power of the middle class, which has been eroding, and the low-skill end of the labor market, which has borne the brunt of long-term unemployment.
Investors look at the landscape and see stable inflation, a gradually improving job market, and consensus for higher growth in the second half of 2013.
Small businesses look over the horizon and are uncertain about the cost impacts of the Affordable Care Act and mounting regulations associated with this and other new laws.
Kim Sponem, CEO of Summit Credit Union in Madison, said businesspeople are more attuned to the tax and regulatory environments than individuals. While she could not say with certainty that business owners are less optimistic than individual investors, it’s fair to say that federal government gridlock negatively affects business owners’ ability to plan.
Sponem cites inaction on bipartisan legislation that would raise the business lending cap for credit unions from 12.25% to 27.5% of assets, creating an estimated $13 billion in additional credit, according to CUNA Mutual Group, a Madison-based company that provides financial services to credit unions and their members.
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In terms of individual investor optimism, Sponem noted that many investors did better in 2012 than in recent years, and they see more signs of recovery – including rising home values. In addition, there have been a lot of good buys because businesses have been undervalued in the stock market. On the consumer side, she noted that durable-goods purchases can only be put off for so long before consumers have to spend to replace them.
Consumer confidence has ebbed and flowed in recent months, dropping 8.3 points after increasing by about the same level in February. “Seventy percent of the economy is driven by consumer confidence,” she noted. “In 2008-09, consumers pulled back in purchases all at once, deepening the recession.”
David Heidel, a strategist with the Private Client Reserve at U.S. Bank, noted that small business owners have been hit with a one-two punch. Of all the nation’s economic actors, they were the most traumatized by the events of 2008-09, especially the recession’s dampening impact on business credit. In addition, they now face more headwinds in the form of regulation and complexity when it comes to providing medical insurance for their employees.
Looking forward, a number of macro-economic decisions related to the federal budget and the Fed’s timing on raising interest rates above today’s historically low levels have to be made in the next three to five years. Until they are made, it’s reasonable to believe that small businesses will remain in a holding pattern. “That (three to five years) is the time frame small business owners would be concerned about when deciding how to invest their capital and what liabilities to take on,” Heidel noted.
With the fiscal cliff deal, tax rates went up on pass-through businesses, where owners report business income on their personal tax returns. Since about 75% of small business owners operate pass-through entities, some believe this will impact their growth. Jeff Robinson, Grant Thornton’s managing partner for Wisconsin, said the effective tax rate “just increased significantly” for owners of pass-through entities, putting them at a competitive disadvantage. “Investors have a much different reference point than business operators,” Robinson noted. “I’m not surprised there’s a difference between them right now.”
The wildcard of Obamacare
Washington often is cited as part of the problem rather than part of the solution, but while there are vast budgeting differences between the two political parties, at least they are now trying to resolve them as part of the annual budget process, not by manufacturing crisis after crisis.
One wildcard: The impact of the Affordable Care Act, also known as Obamacare, on small business pessimism. Citing higher than expected premium increases, the law’s critics believe it will repeal itself, especially after 33 Senate Democrats joined Republicans in voting for a non-binding resolution to repeal the law’s tax on medical devices.
As full implementation of the ACA approaches, two critiques have emerged, both asserting the law will drive costs ever higher. First, since the law restricts health insurers from charging any one age group more than three times the premium it charges any other one, and with the gap between young and old already five to one, this means younger people and families are about to get socked. Secondly, the federal health bureaucracy is requiring generous coverage for a variety of illnesses and treatments, which is viewed as a cost driver.
The law’s proponents believe it will control costs in the long run, but some short-term projections are ominous. Citing a Society of Actuaries Study, the Wisconsin Insurance Commissioner’s office said providers of some medical policies to Wisconsin individuals face an 80% increase in claims costs by 2017. The report did not make estimates for employer plans, and Obama administration officials said it ignores tax credits contained in the law, which will help people afford their premiums.
Bill Smith, state director of the National Federation of Independent Business, called the ACA a tremendous anchor on the economy. “You cannot expect entrepreneurs to invest in their business, to put their homes and their personal assets on the line, when there is so much uncertainty about the future,” Smith stated. “If you want to grow the economy, if you want to create jobs, and if you want new business growth, you have to have certainty in regulations, certainty in taxes, and certainty in the legal climate or you are not going to get the risk-takers to invest in businesses.
“And with Obamacare and all of the taxes, regulations, and fees associated with it, it’s really putting a tremendous drag on economic growth.”
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Mike Harris, president and CEO of Patina Solutions, was a small business owner in the eye of the 2008-09 hurricane before his ability to raise angel capital helped grow his business services firm into a $15-million-a-year entity. To Harris, who also built Jefferson Wells before it was acquired by Manpower, agreed that small business owners are still frightened by their recessionary experience, and their executives crave certainty about the rules of the game. “The lack of it certainly impacts them,” he stated.
His take on the ACA’s impact is more optimistic because most employers already spend money on medical insurance for their employees. Even though people are trying to gauge the law’s impact, he noted that health care is not an unplanned expense. He’s also seen this type of drama before; the angst over the Affordable Care Act reminds him of the Y2K period. “I remember when Y2K was coming around and we were talking about that at our board meetings,” he recalled. “That was sort of a big topic, and then Sarbanes-Oxley was the big thing everybody was talking about, and then the next big wave is the Affordable Care Act – just the impact it’s going to have. My prediction is that by this time next year, it’s not going to be a hot-button issue. People are going to figure it out and they will have dealt with it and know what their decisions are going to be.”
Others think the shakeout will last more than a decade, and expect that health care spending will continue to increase at a pretty aggressive rate, with or without inflation. If that happens, “we’re going to continually be committing more of our collective productivity and cash flows to health care, so some decisions are going to have to be made on what’s funded through public channels, and what’s funded privately, through insurance companies, to help insurance companies maintain profitable business models while still providing adequate coverage,” Heidel said. “This is something that’s probably going to occupy a big chunk of our thinking publicly for a decade or more, just based on the demographics [of an aging population].”
Staying upbeat
Amid the uncertainty, there are positive currents. The glass of many economists is at least half full, and businesses tend to be more optimistic the closer you get to Madison. In the 2012 First Business Economic Survey, the majority of business owners said they exceeded their expectations for 2012, an indication that worry doesn’t necessarily translate into lower business performance.
Both the housing and automotive markets continue their rebound. Housing’s comeback is reflected in the 40% increase in people taking out a first mortgage during January and February. “We now need more housing inventory,” Sponem noted.
Bill McDonough, Wisconsin market president for Starion Financial, senses broad-based local optimism among his company’s small to medium-sized clients. “Most of our prospects and clients are looking for the remainder of 2013 to be strong,” he said. “We’re seeing pretty consistent revenue growth year over year, even as shallow as we are into 2013. We’re seeing a fair amount of optimism for the rest of the year, and that’s based in part on results year to date.”
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