The Index of Small Business Optimism gained 2.0 points in January, rising to 106.9, again one of the strongest readings in the 45-year history of the NFIB surveys. The highest reading of 108.0 was reached in July 1983 and the lowest reading of 79.7 occurred in April 1980. Six of the 10 Index components posted a gain, two declined, and two were unchanged. The gain left the Index historically strong and maintained a string of exceptional readings that started the day after the 2016 election results were announced. A year after the election-induced surge in Optimism, small-business owners remain confident about the future.

LABOR MARKETS
Job creation was solid in the small-business sector as owners reported a seasonally adjusted average employment change per firm of 0.23 workers, a strong showing. The lack of “qualified” workers is impeding growth in employment. Thirteen percent (unchanged) reported increasing employment an average of 2.4 workers per firm and 9 percent (down 1 point) reported reducing employment an average of 3.4 workers per firm (seasonally adjusted). Fifty-five percent reported hiring or trying to hire (down 4 points), but 49 percent (89 percent of those hiring or trying to hire) reported few or no qualified applicants for the positions they were trying to fill. Twenty-two percent of owners cited the difficulty of finding qualified workers as their Single Most Important Business Problem (up 3 points), exceeding the percentage citing taxes or the cost of regulation as their top business problem. Thirty-four percent of all owners reported job openings they could not fill in the current period, up 3 points from December. Twelve percent reported using temporary workers, unchanged. A seasonally adjusted net 20 percent plan to create new jobs, unchanged from December and at record high levels. Labor markets have become very tight, for both skilled and unskilled workers.

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 5 percent, a 4 point decline following a 14 point improvement in December. The net percent of owners expecting higher real sales volumes fell 3 points, falling to a net 25 percent of owners, still one of the best readings since 2007.

The net percent of owners reporting inventory increases rose 6 percentage points to a net 4 percent (seasonally adjusted). The net percent of owners viewing current inventory stocks as “too low” was a net negative 5 percent, 3 points lower than December. Apparently the buildup of inventories left stocks a bit larger than owners wanted, based on expected sales volumes. However, the net percent of owners planning to add to inventory rose 4 points from December to a net 3 percent. Plans averaged 4 percent in the last six months of 2017 as firms geared up for a solid holiday season.

CAPITAL SPENDING
Sixty-one percent reported capital outlays, unchanged from December and the second highest reading in this recovery to date. This anticipates a substantial increase in capital spending. Of those making expenditures, 44 percent reported spending on new equipment (up 1 point), 28 percent acquired vehicles (up 5 points), and 16 percent improved or expanded facilities (unchanged). Six percent acquired new buildings or land for expansion (unchanged) and 13 percent spent money for new fixtures and furniture (down 2 points). Twenty-nine percent plan capital outlays in the next few months, up 2 points from December. Improvements in productivity depend crucially on investment spending in the labor intensive small-business sector. Improved earnings trends and lower taxes increase the pool of capital available for firms to invest in their businesses. Many of these investments do not involve “high” or new technology, just improvements in standard equipment and processes.

COMPENSATION AND EARNINGS
Reports of higher worker compensation rose 4 percentage points to a net 31 percent, the highest reading since 2000 and among the highest in survey history. Twenty-two percent (up 3 points) selected “finding qualified labor” as their top business problem, the highest reading since 2000, the peak of the last expansion. Plans to raise compensation rose 1 point in frequency to a net 24 percent in response to tighter labor markets, the highest reading since 1989. Small firms are raising compensation to attract and keep the employees they need. The frequency of reports of positive profit trends improved a huge 11 points to a net negative 4 percent reporting quarter on quarter profit improvements, the best reading since March of 1988.

INFLATION
The net percent of owners raising average selling prices rose 3 points to a net 11 percent seasonally adjusted, the highest reading since July 2014. Unadjusted, 9 percent of owners reported reducing their average selling prices in the past three months (down 2 points), and 19 percent reported price increases (up 4 points). Seasonally adjusted, a net 23 percent plan price hikes (up 1 point), although far fewer will report actually doing so in the following months. There is a strong dynamic in price adjustments on Main Street that is typical of a less regulated market.

CREDIT MARKETS
Three percent of owners reported that all their borrowing needs were not satisfied, unchanged and historically low. Thirty-one percent reported all credit needs met (down 1 point) and 52 percent said they were not interested in a loan, unchanged. Only 2 percent reported that financing was their top business problem. Three percent reported loans “harder to get’, unchanged and at historic lows. Thirty-one percent of all owners reported borrowing on a regular basis (down 3 points). The average rate paid on short maturity loans was down 20 basis points at 5.9 percent. If the Federal Reserve raises rates the anticipated three times this year, variable rate loan costs will respond immediately, although longer term rates are not likely to reflect the full hike.

COMMENTARY
The new tax law, the Tax Cuts and Jobs Act, produced the most recent boost to small business optimism. And federal government related cost pressures continue to abate, offering a more supportive business climate for small firms. Consumer spending remains supportive, and business spending and housing remain strong.

On the Federal Reserve front, the minutes of their last meeting revealed a discussion of inflation that mirrored much of the recent public discussion by Former Chair Yellen, who acknowledged the difficulties the committee has in understanding current inflation dynamics and why inflation continues to remain below target, despite very accommodative policies. It is worrisome that our central bank wants to create inflation and assumes that once it has “enough”, it can keep inflation from going higher. The Federal Reserve’s forecast is that inflation will continue to rise and then stop at their target of 2 percent, they offer no explanation of why or how it will stop. And, there is no rigorous explanation of why 2 percent is the “right’ level for the economy. If it is not, pursing policies that try to increase inflation could become even more damaging to the economy, hurting the small business sector. In the meantime, the Federal Reserve will continue to raise rates.

The U.S. ranked second in the World Economic Forum (Davos)’s assessment of global competitiveness. Strong points included inflation, venture capital, business sophistication, innovation, financial market development, labor market efficiency, and higher education and training. Not so good U.S. ranking included 61st (out of 137 economies studied) on business costs of crime and violence, 57th on organized crime, 39th for internet use penetration and 95th on tax rate as a percent of profits (pre tax law). The extensive size and performance of our small business sector plays a key role in supporting these rankings and now government policies are more focused on strengthening the competitiveness and performance of this sector by reducing regulatory and tax restrictions that waste time and capital. The new tax law is one more significant step towards establishing a pro-growth environment supporting the small business sector.