Brace For Impact: Small Business Spending Suddenly Tumbles, First Annual Drop Since Jan 2021

One week ago we showed that in a dramatic reversal of recent “strong consumer” trends, the latest debit and credit card data from Bank of America showed that US household spending just hit a brick wall, dropping -1.2% for the first time since February 2021, where the highlight was a continued slide in service spending (which until recently had been driving overall spending growth) to just +0.9% YoY, and about to turn negative.

Just as ominously, the data showed that contrary to a rebound in retail sales and continued strong wage “data” from Biden’s BLS, the spending weakness was actually driven by the higher-income cohort whose spending remained below lower- and middle-income households and, moreover, higher-income households spent less in April compared with one year ago.

Completing the dismal trifecta, after-tax wages for the higher-income households actually contracted by 1.3% YoY in April 2023 on a three-month rolling basis, the second consecutive month of decline, and a powerful wake-up call to a Fed which still believes that all wages are rising at mid-4% annual pace.

Which brings us to the latest report from the Bank of America Institute, which this shifts away from households and this time looks at small business data – the dynamo that not only powers the bulk of the US economy but is also responsible for the majority of hiring across the economy – only to find a dramatic deterioration across the board.

The report starts off by highlighting the latest, April, release of the National Federation of Independent Business (NFIB) survey, in which small business sentiment dropped to 97.4, the lowest reading since January 2013, which clearly indicates that “small businesses (SB) are feeling less optimistic.”  As BofA explains, this was in part driven by weaker reported sales revenue and continued pessimism on the economic outlook.

Why is sentiment important? Simple: falling sentiment means businesses are less likely to spend. In fact, according to the Spring 2023 Bank of America Small Business Owner Report, nearly half (42%) of business owners indicated they are reevaluating cash flow and spending (by extension, this means a collapse in loan demand, which is a death sentence for those small banks which are already bleeding tens of billions in deposits weekly as they can’t keep up with rates on Money Market funds).

According to BofA, small businesses are pulling back spending in two areas: capital expenditure (capex) and hiring. According to the same NFIB survey, in April only a net of 19% of small business respondents reported plans for capex in the next three to six months, the lowest reading since November 2012 (excluding the Covid-induced plunge in April 2020).

While the BofA analysts did not have a capex breakdown of total small business payments based on Bank of America internal card data, a large portion likely falls under automated clearing house (ACH) payments as ACH captures bigger ticket purchases than card spending. As the next chart shows,

While one can debate the nuances, the bigger picture is quite clear: overall small business payments are showing signs of cooling. According to Bank of America internal card data, total payments per small business client, which includes ACH, cards, wires, checks and person-to-business payments, contracted by 8% year-over-year (YoY) in April. To be sure, there are some unfavorable base effects since payments levels were elevated a year ago, so even with the YoY decline, the level of small business spending remains strong by historical standards, but the trend is only accelerating in the wrong direction.

Within components, ACH payments per small business client slipped into contractionary territory at -4% YoY, the first negative reading since January 2021. Meanwhile, credit and debit card spending per client was down 6% YoY, its second consecutive negative monthly YoY reading.

Digging deeper into the numbers, BofA found that not all sectors are affected equally by the macroeconomic  slowdown. The next chart shows the total payments per small business by select sectors and reveals that real estate and wholesale trade are the two sectors with the biggest YoY contractions.

payment growth outpaced that of total payment growth in 2022 when capex intentions were also fairly elevated. However, the gap has been closed as of April’s reading.

Weakness in real estate small business payments reflects general weakness in the housing market, where existing home sales remained more than 20% lower than a year ago in March and real estate activity is depressed by soaring interest rates and low affordability. Meanwhile, wholesale trade could be feeling downward pressure from sluggish overall goods spending and lack of a strong China recovery. Interestingly, small businesses in manufacturing are experiencing 6% YoY growth in total payments per client in April, despite the ISM Manufacturing Index suggesting the sector is in a recession. One possible explanation is that the ongoing onshoring practices have led to businesses increasing their investment for future use.

As if that wasn’t enough, small businesses are also getting hammered by the sharp tightening in credit conditions which are adding to expenditure headwinds, and which the Fed believes will serve as a monetary policy substitute brake on spending and inflation. Last month, we argued that banks had already started to tighten lending conditions in 2022 and recent developments in the banking sector suggest this will continue, if not accelerate.