The Index of Small Business Optimism gained 0.8 points to 103.8 in October, maintaining a streak of robust readings. Four of the 10 Index components posted a gain, 5 declined and one was unchanged. Labor market indicators point to continued good jobs reports, as reports of actual employment gains for October posted solid numbers and reports of job openings surged to record territory. Reports of increased compensation remained strong, and the incidence of reported price increases rose a bit, good news for the Federal Reserve, which wants more inflation. Plans to spend on inventory and capital projects didn’t advance but held at solid levels. Owners became much more optimistic about the environment for expansion, which implies a more positive longer-run view. In the nearer term, they are more optimistic about real sales growth and improved business conditions through the end of the year. The net percent of owners reporting positive sales trends did not improve but did remain positive.

LABOR MARKETS
Job creation strengthened in the small-business sector as business owners reported a seasonally adjusted average employment change per firm of 0.17 workers. Fourteen percent (up 2 points) reported increasing employment an average of 3.5 workers per firm and 11 percent (down 2 points) reported reducing employment an average of 2.2 workers per firm (seasonally adjusted). Thirty-five percent of all owners reported job openings they could not fill in the current period, up 5 points, the highest reading since November 2001. Fifty-nine percent reported hiring or trying to hire (up 2 points), but 52 percent (88 percent of those hiring or trying to hire) reported few or no qualified applicants for the positions they were trying to fill. Twenty percent of owners cited the difficulty of finding qualified workers as their Single Most Important Business Problem (up 1 point), second only to taxes and the highest reading since 2000. This is the top ranked problem for those in construction (31 percent) and manufacturing (27 percent). A seasonally adjusted net 18 percent plan to create new jobs, down 1 point from September’s strong reading.

CREDIT MARKETS
Four percent of owners reported that all their borrowing needs were not satisfied, up 2 points and historically low. Twenty-nine percent reported all credit needs met (down 4 points) and 53 percent said they were not interested in a loan, up 2 points. Only 2 percent reported that financing was their top business problem compared to 21 percent citing taxes, 14 percent citing regulations and red tape, and 20 percent the availability of qualified labor. Thirty percent of all owners reported borrowing on a regular basis (up 1 point). The average rate paid on short maturity loans was up 40 basis points at 6.0 percent, little changed even as the Federal Reserve has been raising rates.

SALES AND INVENTORIES
The net percent of all owners (seasonally adjusted) reporting higher nominal sales in the past three months compared to the prior three months was a net 1 percent, unchanged from September. Consumer spending slowed at the end of the third quarter and hurricanes definitely depressed shopping in large parts of the country. Seasonally adjusted, the net percent of owners expecting higher real sales volumes gained 6 points, rising to a net 21 percent of owners, after a 12-point drop in September. What triggered September’s large decline in expectations is less clear, as reports on the economy were fairly good.

The net percent of owners reporting inventory increases rose 2 points to a net 0 percent (seasonally adjusted). Inventory building did occur for the economy as a whole, but in the form of reduced rates of depletion in the small business sector. The net percent of owners viewing current inventory stocks as “too low” lost 2 points to a net negative 5 percent, a less positive view of the need for current stocks. This is a bit surprising in light of the rather positive view of real sales trends in the next 3 months. The net percent of owners planning to add to inventory fell 3 points to a net 4 percent, a solid figure that is supportive of fourth quarter growth.

INFLATION
The net percent of owners raising average selling prices rose 2 points to a net 8 percent. Clearly, inflation is not “breaking out” across the country as the Federal Reserve hoped. Ten percent of owners reported reducing their average selling prices in the past three months (unchanged), and 16 percent reported price increases (up 1 point), illustrative of the dynamics of price adjustments in the private sector to changes in economic conditions and demand. Seasonally adjusted, a net 22 percent plan price hikes, although far fewer will report actually doing so in the following months.

COMPENSATION AND EARNINGS
Reports of higher worker compensation rose 2 points to a net 27 percent, historically strong. Owners complain at record rates of labor quality issues, with 88 percent of those hiring or trying to hire reporting few or no qualified applicants for their open positions. A near-record 20 percent selected “finding qualified labor” as their top business problem. Plans to raise compensation rose 3 points in frequency to a net 21 percent, following a 3 point rise in September. Gains in compensation are to be expected when labor markets are very tight as they appear to be.

CAPITAL SPENDING
Fifty-nine percent reported capital outlays, unchanged. Of those making expenditures, 41 percent reported spending on new equipment (up 2 points), 24 percent acquired vehicles (up 1 point), and 16 percent improved or expanded facilities (up 3 points). Seven percent acquired new buildings or land for expansion (up 1 point) and 12 percent spent money for new fixtures and furniture (unchanged). The percent of owners planning capital outlays was unchanged at 27 percent. The recovery from the hurricanes will undoubtedly raise these numbers.

COMMENTARY
The preliminary estimate of third quarter growth came in at 3 percent, but this figure will be revised several times before the “official” figure is reported. It was virtually unchanged from the 3.1 percent growth for the second quarter. Domestic spending was weaker, closer to a 2 percent rate of growth. Residential investment spending faltered a bit, perhaps due to supply constraints, such as shortage of labor, not weaker demand. Consumer sentiment surged based on optimism about jobs and incomes, an encouraging development as consumers account for 70 percent of GDP. There will be a pickup in auto spending (replacing hurricane-damaged cars) and home improvement spending, due to hurricane damage, and the rising prices of houses due to a shortage of new supply.

The Federal Reserve will boost rates again in December, by 25 basis points, putting the policy range at 1.25-1.5% for Federal Funds. But that will leave the rate at about half of the level that history would suggest. It will also stop reinvesting $10 billion of maturity proceeds each month, gradually increasing this to $50 billion per month. The Federal Reserve has not signaled how much lower it will take its $4.5 trillion portfolio, but the reduction will be slow. Less Federal Reserve buying, however, will put some upward pressure on interest rates. The Federal Reserve is still in control of rates and bond investors will bet on the Federal Reserve, not markets. New Federal Reserve management will soon be in place and it will like set a less cautious path for “normalization.”

Congress has taken its first cut at tax reform and small business owners are eagerly waiting to see how the developing legislation will benefit them. Historically, Congress has given inadequate consideration of the impact of their laws on small firms, paying more attention to lobbies from the largest firms and unwittingly saddling small firms with costly and inappropriate (of little or no value to society) regulations promulgated for large firms. Owners remain hopeful that whatever the final tax legislation looks like, it will be a positive change from current law.