Small-Business Sentiment Is No Help to Investors
Surveys of how entrepreneurs are feeling have proven to be of little value.
Bloomberg, February 21, 2018.
President Donald Trump took a brief break from tweeting about Russian electoral interference (“No Collusion!”), #MeToo (Fake News!) and gun violence (Very Sad!) to tweet about small-business optimism.
This is an issue near and dear to me, involving actual business owners (and not economists), psychology and the use of sentiment readings as a trading signal.
At risk of creating a straw man argument, the problem we run into with most sentiment measures is that are backward-looking. They inform us what people may be feeling about what already took place, especially with regard to markets. Questions can be posed that are forward-looking — what are your hiring plans? how much do you plan to spend on holiday gifts — but sentiment readings typically reflect what just occurred. 1
This came up the other day when Trump cited a CNBC/SurveyMonkey Small Business Confidence Index.
Main Street is BOOMING thanks to our incredible TAX CUT and Reform law. “This shows small-business owners are more than just optimistic, they are ready to grow their businesses.” https://t.co/w9aw68UwOj
— Donald J. Trump (@realDonaldTrump) February 20, 2018
That survey has a relatively short history, so I’m not entirely sure how much weight to give it. But there is another survey, the granddaddy of small business confidence measurement, conducted by the National Federation of Independent Business (NFIB). Its Small Business Optimism Index has been around for 45 years.
Sentiment surveys have their own unique issues, and the NFIB long-term series is especially emblematic of those problems. Except when these readings hit true extremes, they contain little actionable information. As an example, consider the recovery from the financial crisis, from 2010 on. The NFIB sentiment data was consistently negative. Small business owners, like traders and larger business owners, suffered from the sort of post traumatic shock disorder that the Great Recession inflicted on almost everyone. Any business owner (or trader) who used those sentiment surveys as a guide to making business or investment decisions missed an enormous move higher in consumer spending, employment improvement and the stock market.
Jason Goepfert, of sentimentrader.com, notes the difficulties in finding trading signals in sentiment data:
Sometimes, big spikes in optimism equate with peaks in stocks, but usually not. And sometimes divergences have been helpful, e.g. in 2000 when stocks were hitting highs but small business were getting more and more pessimistic. But like most divergences, they can go on for months or years, so using it for timing is next to impossible. It started to diverge 3 years before the market peak in 2007, and then was showing extreme pessimism by December 2007, which obviously was an exceptionally poor contrary indicator.
As recently as 2015, I noted how far behind the economy the NFIB small-business optimism survey was lagging. The economy was more than five years into the recovery before the readings moved above their long-term average.
Back to Goepfert and the inherent challenges of using this data: “The bottom line to me is that whatever your bias is heading in, you can probably find something in the data. But as an objective, consistent measure I don’t find it helpful.”
So although President Trump may like what he sees in the small-business survey, it contains little if any usable information for investors trying to decide where to put their capital.
Originally: Small-Business Sentiment Is No Help to Investors