Small businesses send recession warning signal

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The Federal Reserve is raising interest rates aggressively to fight the worst inflation in 40 years, and such campaigns have tended to tip the economy into recession. Yet most economists still believe the United States will avoid such a fate, at least in the next 12 months, with the obvious exception of William Dunkelberg, chief economist at the National Federation of Independent Business, the largest organization small businesses in the country. He predicts a 70% chance of a recession next year, largely based on his analysis of the NFIB’s proprietary surveys of small businesses, which he launched nearly five decades ago. I spoke with him about the rationale for his off-the-beaten-track projection. A lightly condensed and edited transcript of the conversation follows.

Jonathan Levin: Why do you think a recession is more likely than not over the next 12 months?

William Dunkelberg: We’ve been tracking small business optimism since we started the survey in 1973. So we’ve been through many recessions and booms, and we’ve developed a set of indicators to see how the economy is doing. And one of the best indicators in terms of the timing of a recession is a question about trading conditions six months from now. It’s a simple question, “Do you think it will be better, the same or worse?” And we look at the net percentage that says better, and that’s the lowest in the 48 years that I’ve done the survey. Specifically, each time it dipped, we had a recession soon after, and of course that’s the position we find ourselves in. So where did I get 70% from? Basically, I looked at our numbers and said we predicted at least 70% of recessions – maybe all of them depending on how you want to view the timing. When we crash, the economy seems to crash.

JL: What other key indicators lead you to believe that we are headed for a recession?

WD: Another question we ask is about actual expected sales – actual volume so we can discount inflation – and that percentage is also a big negative number. Companies therefore have a very sad view of the sales they are going to be able to make in the second half of the year, even if now they are scrambling to hire workers and make hay while the sun is shining. But they don’t think it’s going to last, so it looks really bad. Another question we ask is, “Is this the right time to grow your business?” And that’s about as low as we’ve ever seen it dive. No one wants to grow their business, and it shows in the questions we ask about capital expenditure plans; they are not crushed, but they are quite weak. So all of these things don’t look very good for the Main Street economy and, of course, that’s a big chunk of the economy.

JL: You have access to a lot of interesting survey data. But as we’ve seen in other surveys — including consumer sentiment — this economy is in a strange place, and people’s actions don’t necessarily match their verbal assessments of how bad the economy is. How do you balance words and actions in your economic forecasts?

WD: Small businesses are really the interface between producers and consumers. You don’t buy a car from Ford Motor Co., you buy it from a dealer who then communicates with Ford about the nature of the demand at that time. Obviously, the consumers are not very satisfied, and that of course represents two-thirds of the economy. So as it gets worse, things won’t look so good. If you look at what’s happened to the retail sales numbers over the last two months, they’re deteriorating, especially when you adjust them for inflation. We [small businesses] picking that up and messaging the big production companies and letting them know if we want more cars or less or whatever.

JL: Do you have any idea how bad a recession that might be?

WD: To characterize it as a “sensation” would be fair. I would argue that the steeper the decline in our index on expected trading conditions, the more severe the recession. So if you look at the 1975 recession in the charts, we didn’t have much of a downturn, although we clearly did; ’80-’82 was bad and our indicator really dropped on that one. And it really dropped before the 2008 recession, and it dropped for a month or two in 2020 when the government shut down the economy.

JL: What do you think of the argument that the labor market still looks strong and household savings and wealth provide a cushion?

WD: It could. What we had, of course, was that the government sent checks to everyone. Economics has a theory about it, and it says you get a big lump sum of money, what do you do with it? You save it, unless you think it’s going to keep coming. We didn’t think this would happen, we knew these were short term gains. Indeed, the deposits accumulated rapidly. So we have a lot of money, a trillion or two, and there’s evidence that we’ve used some of it, but not a lot. It is a wealth, and we preserve it. The other thing to note is that the use of revolving credit is now back, so people who don’t have savings or don’t want to use it are using credit – and it’s usually not a good thing once he gets to a high-level record.

A group of us, and more people than before, have a lot of stock market wealth. The Fed stopped me from being in bonds, so I got way too much in the stock market, and it was a bad experience. On paper, you are losing a lot of money. And it’s not very helpful for optimism or spending. So I think these things fit pretty well with the idea that the economy is going to be weak soon – and maybe quite dramatically.

JL: This looks like perhaps the most anticipated recession of all time. What do you think of this notion that we talk so much about a recession that it becomes a self-fulfilling prophecy?

WD: Psychology is very important. That’s why the Consumption Index was started in the 1950s by a psychologist, George Katona, who said that how people feel determines their decisions about this stuff. Now we have a lot of surveys like ours, the Michigan and Conference Board survey, etc., that look at expectations. So it’s possible, but I think most data is data drives where you think things are going to go, and it’s pretty hard to be optimistic when you’ve lost 20% of your retirement portfolio and you see interest rates rising so dramatically. that house you thought you were buying, you can’t now — you can’t qualify for the mortgage or you don’t want to. So the facts on the ground will continue to play a major role in determining how people perceive what’s to come.

Statements can matter. Jay Powell can say what he wants about the future, but the numbers come out, and that’s really what we’re looking at.

JL: What would make you change your mind about the recession?

WD: It’s not something you want to happen, but the Fed might say, “You know, we shouldn’t raise rates, we should start cutting them again.” We liked the zero terminal. This can prevent us for a short time from sinking into recession. The housing market would get strong again and more people would borrow and blah blah blah. Asset prices would rise. I don’t think that will happen at all. I think the Fed is going to stay the course, and we’re going to see a traditional recession coming from the Fed, you know, waiting too long, stepping on the brakes, pulling the emergency brake along with the foot brake, and we will slide into a recession. And then we’ll have to see what comes out of us.

More writers at Bloomberg Opinion:

• Markets signal Pyrrhic inflation victory: John Authers

• Powell Wisely has an overview of inflation: Jonathan Levin

• Bond market rebound is bad news for economy: Gary Shilling

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Jonathan Levin has worked as a Bloomberg reporter in Latin America and the United States, covering finance, markets, and mergers and acquisitions. Most recently, he served as the company’s Miami office manager. He holds the CFA charter.

More stories like this are available at bloomberg.com/opinion

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