Economic confidence is up, but hold the celebration

This past spring the U.S. economy marked the fifth anniversary of the current economic expansion. I choose to use the word “marked” rather than “celebrated” here because the pace of growth in the economy during the past five years has been frustratingly lackluster. To be sure, slow growth is better than negative growth, and five years is a respectable length of time for a period of economic recovery. But unless you are one of the lucky few in the extreme upper income bracket, this past five years has probably not been excessively comfortable.

Conditions that have historically generated more robust growth during past recoveries have not prompted the same result so far this time. These include: low interest rates, record levels of corporate profits, an all-time high in the stock market and improving access to capital. And it has become increasingly clear that despite these highly accommodative economic fundamentals, the main obstacle to faster economic growth is a pervasive lack of confidence amongst both businesses and consumers.

Ever since the Great Recession ended in 2009, the U.S. economy has struggled to find its groove, its mojo and its swagger. This lack of confidence is stuck at the point of a self-fulfilling prophecy, and the result is vicious cycle of tepid economic growth. Consumers lack the confidence to demand more goods and services because they have doubts about the future trends in employment and income levels. Businesses are hesitant to invest in new employees and equipment because of doubts about near-term trends in consumer demand. So here we are after five years — still waiting for things to pick up.

But at long last things may actually be getting better. The ever-so-tenuous trends in confidence levels are finally starting to rise.

The latest reading for the Index of Small Business Optimism was 96.6 in May (1986=100). The index is compiled and reported each month by the National Federation of Independent Business (NFIB). This was the third consecutive monthly increase for this index, but more importantly from my perspective, this was the highest index value since September 2007. That's right, small business confidence levels just hit their highest mark in almost seven years.

As the accompanying chart illustrates, this index has been stuck in a range between 88 and 95 for the past three years. But in May, there was a breakout to the upside of the range represented by the value of 96.6. Those of you who study the stock market will likely recognize this technical pattern in the chart, and if you do, then you know that such breakouts often presage an uptrend in the data.

Now I do not want to push this stock market analogy too hard. Technical analysis of chart patterns, even for hard numbers such as stock prices, is far from an exact science. And this NFIB index does include a number of “soft” components such as “future expectations” that are difficult to quantify consistently. But I do believe this data is relevant, and I will push the importance of any good news coming out of the small business sector of the U.S. economy.

I do not know how many of you, if any, participate in the monthly NFIB survey, but I know that many plastics companies qualify as small businesses. I know that small businesses are the engine that drives growth in the U.S. economy, and these businesses usually account for most of the increases in new jobs. And I also know that small businesses were hit disproportionately hard by the recession and have been slower to recover. Stronger economic growth will only be possible with the full and enthusiastic participation of America's small business sector.

And I think that it is more than mere coincidence that the current rise in small business confidence corresponds with the recent uptrend in the data from the plastics industry. According to data from the Federal Reserve Board, the respective indicators that measure the volume of plastics products manufactured in the U.S. as well as the rate of capacity utilization in the plastics industry both reached their highest monthly level in May since the fourth quarter of 2007.

Because of their ubiquitous nature, demand for plastics products is a reliable, broad-based indicator of total U.S. economic activity. And it is quite likely that demand for plastics products also has a strong correlation with business levels for many types of small businesses. So it will not surprise me if the trends in these data start to rise together in the coming months due to an element of mutual reinforcement.

But before we start celebrating rather than just marking these recovery milestones, I am compelled to point out that in the commentary that accompanied the recent release of the Index for Small Business Optimism, the NFIB writes that the May reading “is still below average and far from what is considered to be an expansion level.” They write of the latest three-month uptrend that “we have had quite a few of these along the way that didn't pan out.” They also point out “that virtually all of the gain (in the May index) came in expectations for sales and for business conditions,” and not in the components of the index that account for actual spending and hiring changes.

To paraphrase, small business confidence levels are the highest they have been in seven years, but things could still go down from here. Now I mean no disrespect whatsoever to the good analysts at the NFIB who competently and reliably compile and report this very useful data. Nobody is better at doing what they do. But that is what I mean about a lack of swagger.

As it pertains to the economy, things could get worse in the near-term. But that is always true, is it not? What is also true is that hiring a new employee, buying a new piece of equipment, and pitching a new customer are all acts that require confidence. Business people need confidence before they make these important decisions, and they need confidence after the fact in order to do whatever is necessary to ensure that the decision was correct. In other words, it takes a lot of confidence to make this economy work right. And I have confidence that this is starting to happen.

Bill Wood is economics editor for Plastics News, and is the founder and president of Mountaintop Economics and Research Inc.