Benjamin Tal - Small business slowdown signals sluggish economy?
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Small business slowdown signals sluggish economy?

Benjamin Tal
Deputy Chief Economist,
CIBC World Markets

“This economic cycle is very old. We are the third longest cycle now. And within a few quarters it would be the second longest cycle ever. And you know what small businesses are starting to slow down. They're usually the pioneer of the economic cycle. Small businesses account for roughly only 30 percent of economic growth. But it's 95 percent of the number of companies in the economy. So you can see that really it's a very important segment of the economy. And recently we're getting some signals from small businesses in Canada that they’re getting tired. You know the rate at which they’re hiring people is slowing down, confidence is down. This means that the economy probably will slow down over the next two to three quarters and into 2018. So, that's a very important signal from an investment perspective because they are basically leading the economy telling us where the economy will go. And large companies will follow them too.”

Challenges ahead

“Many of those small businesses are telling us that they are facing major, major challenges. Not only is the cycle mature but also we are seeing minimum wage rising. We've seen the proposed tax aspect that is clearly negative for small businesses, and we see NAFTA. Even though many of them are not really trading, about 50, 60 percent of them are telling us we are very concerned about NAFTA. It's already impacting their decision making process. The dollar itself, namely the value of the dollar and the recent increase in the value of the dollar, is not the major driver. We look at the past history and we see the correlation between small business confidence and the value of the dollar, it's not really there. Some companies that export their goods and services they will feel the pain. But also companies that import stuff will benefit from that. So the balance is basically flat. But some companies will feel the pain.”

Impact of Rising Rates

“As we all know the Bank of Canada started to raise interest rates and small businesses are sensitive to the risk of higher interest rates not because of the fact that they have so much debt. In fact the opposite is the case, despite low interest rates, small companies resisted the temptation to borrow. They deserve credit for not taking credit. At the same time they are very sensitive to the increased risk of the consumer to higher interest rates because the consumer is 80, 90 percent of those businesses business.
The consumer will slow down due to the increase in interest rates. Clearly the housing market is going to slow down, it's already happening. That will impact the psyche of the consumer, which in turn will impact the ability of small businesses to excel. The good news is that the Bank of Canada is not going to take interest rates to the sky anytime soon. They raise interest rates by 50 basis points and they're going to rest a little bit. The reason is that inflation is not rising. The dollar the Canadian dollar went up that would slow down the economy. So the Bank of Canada is basically communicating to us that the economy, consumers and small businesses will have enough time to adjust to the new reality.”

Drivers of growth

“What is the secret to success. We found that, it's interesting, that there are many companies that grow relatively fast. They have a lot of outsourcing work. Basically they get a lot of work from large corporations so the interconnection between small businesses and large corporation is very important when it comes to overall growth, as well as many of them exporters. So clearly diversifying your base and trying to export more is very important for your future as a small business owner. And of course we have a situation in which many of them are relatively young and the younger you are the faster you grow.”

Signals for investors

“In terms of investment I think that clearly if you look at the overall equity market you need some sort of signals or leading indicators I suggest that if you follow the small business segment of the economy that's the pioneer of the cycle. It tells you more of less where the economy is going sometimes even before the stock market because those are not credible equities. Those are basically people making a decision on a daily basis. They lead the economy. Small businesses are telling us that we are moving from a four point five percent GDP growth to about 2 percent GDP growth. That's a signal that we are getting. In this case I will say my investment in growth oriented stocks and I will look at the value oriented thoughts. They usually excel when the economy is starting to slow.”