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The July 2024 NFIB Small Business Optimism Index posted a surprising increase, rising 2.2 points to 93.7, the highest level since February 2022. While this boost in confidence might seem like good news on the surface, a deeper dive into the data suggests that small businesses and by extension, small cap stocks, may face some struggles in the remainder of the year.
The increase in optimism appears to be driven by a significant 18-point improvement in expectations for economic conditions, reflecting hopes that the Federal Reserve might begin cutting interest rates later this year. However, it's important to note that even with this improvement, the index remains below its historical average for the 31st consecutive month. This prolonged period of subpar performance highlights the persistent challenges facing small businesses, including inflation and labor quality, both of which remain top concerns.
Inflation, in particular, continues to plague small businesses, with 25% of owners citing it as their most pressing issue. This represents a notable increase from June, signaling that cost pressures are not abating. While some relief in wage pressures was observed, 33% of businesses reported raising compensation. While this was down from previous months this reduction might not be enough to offset the broader economic uncertainties.
Perhaps most concerning for small-cap investors is the sharp rise in the NFIB’s Uncertainty Index, which jumped to 90 in July, the highest level since November 2020. This surge in uncertainty reflects growing concerns about the upcoming U.S. presidential election and potential shifts in economic policy. Small businesses, which are often more vulnerable to changes in regulation and economic conditions, are increasingly unsure about the future.
For small-cap stocks, which are closely tied to the health and sentiment of small businesses, this uncertainty is troubling. Historically, small caps have been more volatile than their larger counterparts, and periods of high uncertainty can exacerbate this volatility. The combination of ongoing inflation, labor market challenges, and a contentious political environment could weigh heavily on small caps in the coming months.
Despite the uptick in optimism, the road ahead for small businesses and small caps remains fraught with challenges. The NFIB report underscores the difficulties that small businesses are likely to face as they navigate an uncertain economic landscape. Investors in small-cap stocks should be cautious, as the high uncertainty of inflation, interest rates and potential political upheaval could lead to increased volatility on these stocks.
In conclusion, while the July NFIB report offers a glimmer of hope with its rise in optimism, the spike in uncertainty from are an indication of the concern that the company leaders have of the potential difficulties lying ahead of them. Small caps, often seen as a barometer for broader economic health, may struggle in the face of these challenges leading to higher volatility until these question marks facing the economy become clearer.