Up until now, small business has actually been one of the great, unsung success stories behind the continued strength of this economy. But that may be about to end.
Small businesses--those with fewer than 250 employees--have accounted for a disproportionate share of hiring and job openings since the pandemic hit. Almost 78% of all job openings as of December, up from 72% pre-pandemic, were driven by small business, according to Aneta Markowska at Jefferies.
Why has small business been so strong? Let's remember the explosion of start-ups the pandemic unleashed. The largest increase was in the South, where new business formations are still running 43% higher than pre-pandemic; but on average across the country they're still up an impressive 35%, per Jefferies. In other words, we've seen a surge of new businesses, which need to hire quickly. Indeed, since the pandemic hit, companies with fewer than fifty employees have driven almost 90% of the labor demand.
The higher relative share of small business job openings last year was also because larger businesses were starting to retrench. A key reason for that was the collapsing stock market, especially for shares of high-flying tech stocks. These firms "were forced to cut costs quickly to preserve cash," as Markowska notes. But many workers who were laid off last year were able to quickly find new work as the broader economy, including smaller companies, chugged along.
However now, in 2023, conditions are very different. The pain is shifting, and those most affected are the ones most sensitive to higher borrowing costs, costlier labor, and slowing end-price inflation--namely, small businesses.
"Small business profits are likely to plummet in Q1," Markowska warned over the weekend. "Why? Because pricing power is waning, while labor is striking back." Wages are about to catch up to inflation, "ending the unprecedented profit run for small businesses," she added.
Plus, while larger companies can rely on tapping the bond markets to raise money--and many have already refinanced at lower rates--smaller and newer ones aren't so lucky. "Small businesses tend to borrow from banks and have more floating-rate exposure," Markowska wrote. And they are only just beginning to feel the full pain of these rate hikes; their average financing costs could hit almost 10% by this summer--double what they were in 2021--as the Fed keeps hiking, she added.
Higher costs meaning falling profits, which mean layoffs are coming in the months ahead for these businesses that have been the broad underpinning of the post-Covid economy. It's why Markowska continues to think a recession will begin in the back half of this year. And it's perhaps the best illustration of why we shouldn't be lulled into thinking now--prematurely--that the Fed should keep doing more rate hikes because the economy has been "just fine."
See you at 1 p.m!
Kelly
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