Small Business Loans Drop: Does This Foreshadow a Slowing?

By George Leong for Investment Contrarians

Small business is the backbone of America’s economy. While large multinational companies tend to get all of the attention, it’s the small companies that are critical to the country’s economy.

From your local “mom and pop” shop to the independent watering hole around the corner to the small manufacturing company making widgets, small companies are critical to the economy.

These are the companies that tend to fare better than other companies when coming out of a recession or a slowdown, due to their ability to make quick decisions in response to rapidly changing business variables.

While large companies could take months to adapt to a changing business environment, small companies could take only days or weeks to adjust, which is why their activity should be monitored.

An interesting measure on how well small companies may be doing can be linked to the amount of loans taken out. The thinking is: the higher the loans, the more the business is growing.

The Small Business Lending Index (SBLI), developed by Thomson Reuters and PayNet, is a good benchmark on small business lending. The SBLI is based on the volume of new commercial loan and lease originations from the major lenders in the U.S. given to small companies.

In March, the index fell to 98.5 from 105.4 in February.

The SBLI chart shows the pattern of the loans from 2005. You will notice the dip in loans when the recession surfaced, followed by the steady rise in loans to small companies up until the present time. Also note the recent big dip in loans to small companies.

This recent decline may prove to be nothing important, but it could also indicate an impending slowdown in loan demand by small companies on the horizon—potentially foreshadowing an upcoming slowing in the business climate and U.S. economy as small companies clamp down on spending used for company expansion, such as jobs growth and adding capacity via machinery.

The SBLI chart is featured below:

While we may be somewhat premature in suspecting the possible slowing, it is important to monitor the lending situation.

In the economy as a whole, factory activity may be stalling, as indicated by the key Institute for Supply Management (ISM) index, which fell to 50.7 in April, down from 51.3 in March. While the reading still indicates expansion in manufacturing, the low reading indicates stalling and is the lowest reading since December 2012, when 50.2 was reported, according to the ISM.

So, while the Federal Reserve’s easy money policy has helped to drive the economy, the red flag indicated by the slowing in loans made to small companies is worrisome. As such, you may want to be careful when buying stocks during this time because the economy could be set for some stalling.

This Article Small Business Loans Drop: Does This Foreshadow a Slowing? was originally published at Investment Contrarians