As in 2019, we see many of the same warning signals from the NFIB survey again combined with a high percentage of yield-curve inversions. Notably, out of the 10 yield spreads we track, which are the most sensitive to economic outcomes, 90 percent are inverted.
A surge of analysis suggests the economy may have a “soft landing,” or, rather, will avoid a recession, due to the solid monthly employment reports. It is worth noting that while those employment reports remain strong, we should consider the rapid decline in growth. As we have stated previously, the trend of the data is far more important than the monthly number.
The rapid decline in the three-month average of employment growth coincides with a drastic drop in CEO confidence, suggesting that unemployment will continue to rise as the year progresses.
Non-Confidence
In December, the survey declined to 89.8 from 91.9 in November. While that may not sound like much, it is where the deterioration occurred that is most important.
It is also important to note that small-business confidence is highly correlated to changes in, not surprisingly, small-capitalization stocks. The deviation between small-cap stocks and the NFIB survey will eventually close; the only question is in which direction.
The stock market, and the NFIB report, confirm recession risk is rising. As noted by the NFIB:
“Overall, owners are not optimistic about 2023, as sales and business conditions are expected to deteriorate. Owners will focus on their businesses, and do their best to deal with the fallout from all of the uncertainties in a year of slow growth and still-persistent inflation.”
Many see this in the average of expected sales over the next quarter and actual sales over the last quarter versus retail sales. We likely will continue to see weakness in the consumer over the coming months. That slowing of demand has consequences.
The process of dealing with the fallout includes actions to mitigate risks imposed on businesses from slower economic demand. Such includes layoffs and terminations, wage cuts, inventory reduction, and reduced capital expenditures. The CEO Confidence Index highly correlates with earnings, suggesting further defensive corporate actions.
“Planning” to do something is a far different factor than actually “doing” it.
Sentiment Going Negative
Notably, the NFIB is a sentiment-based survey, like many surveys. This is a crucial concept to understand. As noted, the risk of investing based on improving expectations is problematic as reality can be far different.Another good example is capital expenditure plans. “Business investment” is a crucial component of the GDP calculation. Small business “plans” to make capital expenditures, which drive economic growth, correlate highly with real gross private investment. There are two critical points in the chart below: 1. Capital expenditure plans continue to erode after each recession. 2. The current decline in capital expenditure plans is approaching the lows of the economic shutdown and recession.
As I stated above, expectations are very fragile. The uncertainty arising from inflation, Russia–Ukraine war, and tighter monetary policy continues to weigh on business owners. As noted in the survey:
“Owners continue to call inflation their top business problem, lamenting the cost increases for their inputs (inventory, supplies, labor, energy, etc.) which compel them to raise their selling prices to cover the costs.
“The negative impact of the dramatic increase in interest rates has not been fully felt, and more rate hikes are almost certain early in the year.”
Despite the rash of analysis suggesting a soft-landing scenario for the economy this year, the NFIB survey does not share that sentiment. As noted, the linkage between the economic outlook and capital expenditure plans confirms that business owners are concerned about committing capital in an uncertain environment. While the most recent survey showed hope about the economy, they remain unwilling to “bet” their capital on it.
Don’t Ignore the Data
We again see many of the early warning signs of an economic downturn. While this doesn’t guarantee a recession, it does suggest that the risks of an economic downturn are markedly higher.As noted above, in 2007, the market warned of a recession 14 months before the recognition. In 2019, it was just five months.
No one knows the timing of the recognition of the next recession. However, with economic growth slowing, the Federal Reserve still hiking rates, and inflation weighing on consumers, a “soft landing” seems overly optimistic.
The last time the NFIB signals were this weak, the federal government started sending checks to households, and the Fed introduced $120 billion in monthly quantitative easing. Furthermore, Treasury bond rates fell to 0.5 percent as the Fed scrambled to buy junk bond exchange-traded funds (ETFs).
No two recessions are ever the same. However, if the economy does falter, and companies continue to take more defensive actions to offset the risk of the decline, it is difficult to fathom how stock market prices avoid repricing lower to accommodate for falling earnings.
