Will the Massive Drop in Small Business Confidence Lead to a Bear Market?

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The recent Well Fargo/Gallop Small Business Index cratered in its recent release.  It isn’t so much the direction that should alert investors, but rather the vigor of its descent.  The 26 point drop is the largest since the fourth quarter of 2008 when the stock market stepped off the proverbial cliff.  A small business is defined as an independent business having fewer than 500 employees.  This covers 99.7% of all employer firms and more than 40% of the U.S. private payrolls.  Needless to say, the segment IS the backbone of the economy and its weakness, should it transpire, will reverberate in the economic data and financial markets.  So should investors pay particular attention to this recent data point?  Or is it too early to jump to rash conclusions?

<img src="/media/images/user_36/small-business_large.png" />

Reasons to be Cautious

The obvious answer is that investors shouldn’t put too much emphasis on any data point.  Economic data points zig and zag, some are leading and some are lagging, and of course there are notable revisions that can take place many months after the market has digested the headline-grabbing details.  The National Federation of Independent Business Optimism Index actually ticked up 0.3 in October and appears to be diverging from the Gallop poll.  However, the Gallop poll was conducted AFTER the election whereas the latest NFIB survey is for October.  Maybe the next NFIB survey will reverse to the downside?  There is plenty of reason to believe this is possible given the persistent uptick in government regulation as the single most important problem ever since President Obama first took office (below).  A more emboldened Democratic Party should do little to deter this trend and may have some bearing in the sharp contraction witnessed in the Gallop poll. 

<img src="/media/images/user_36/nfib_large.png" />

Actually, regulation has taken a temporary reprieve as taxes and sales inch higher in recent reports.  Investors should certainly be worried if sales as the single biggest problem start a renewed uptrend, but this assertion seems premature at this point.  The concern over taxes seems obvious given the non-stop rhetoric and record number of special dividend announcements.  And we still have a month left for companies to jump the gun.  Costco (NASDAQ: COST), despite campaign contributions going predominately to the Democratic Party, now sees the need to issue a special dividend.  The $7 dividend announcement sent shares soaring and the company was able to finance the deal with three, five, and seven year bonds yielding 0.65%, 1.125%, and 1.7%, respectively.  So who may still jump the gun this year?  According to a Credit Suisse report, Walgreen and Public Storage are the most likely candidates based on their methodology. 

Reason for Cheer

Taking the other side of the coin isn’t that difficult either.  In fact, the one area of the market that has clearly formed a bottom is housing.  Not only that, but this sector is showing an accelerating upward move.  This is evidenced by individuals’ plans to buy a house within the next six months (below).  The doomsday scenario regarding the enormous housing inventory has diminished significantly as loan modifications and principal reductions remain viable options for banks.  This and, of course, record low mortgage rates help support housing, the economy, and the fragile consumer confidence that drives both.  Improved housing data could have a long bull leg given the dramatic collapse and is why stocks such as Sherwin Williams (NYSE: SHW) and Home Depot (NYSE: HD) have returned 75% and 57%, respectively, this year. 

<img src="/media/images/user_36/housing_large.PNG" />

Putting it all together

Despite the bearishness of the Wells Fargo/Gallop Small Business Index, it seems that calling for a renewed bear market in U.S. equities is premature.  Supporting this notion is the plethora of known bad news (fiscal cliff, weakening China, Europe, etc.) along with more economists anticipating a recession if the fiscal cliff is not averted.  These seem to form a rock solid wall of worry, the very thing that stocks so often climb.  Throw in the clear turn in housing and it appears that at least a floor has been established in risk assets, and any improvement in the known risks could lead to a sharp rally in stocks.  At the very least, a sharp down leg beyond normal market gyrations seems like the least probable outcome. 

market8 has no positions in the stocks mentioned above. The Motley Fool owns shares of Costco Wholesale. Motley Fool newsletter services recommend Costco Wholesale, The Home Depot, and Sherwin-Williams. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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