The small-business hiring engine is sputtering. That's a red flag for the economy.

Small business hiring is significantly decelerating, with the percentage of unfilled job openings falling to 32% in August, its lowest since July 2020, and net hiring lagging larger firms for two consecutive months. This reversal is a critical concern as small businesses contributed over 50% of post-pandemic job creation, and their reduced activity, coupled with increasing financial stress and difficulty finding qualified labor, signals a potential vulnerability for the U.S. economy, especially as a shift towards larger firm employment could amplify job losses during future downturns.

Analysis

A significant deceleration in the small-business hiring engine signals a key vulnerability for the U.S. economy. The percentage of small businesses with unfilled job openings dropped to 32% in August, its lowest point since July 2020, according to the National Federation of Independent Business. Concurrently, for the first time since May 2020, net hiring at firms with fewer than 250 employees has lagged larger corporations for two consecutive months. This trend marks a critical reversal, as small businesses were responsible for approximately 53% of all net job creation from early 2021 through the second quarter of 2024. The shift in employment concentration toward larger, more cyclically-sensitive companies could amplify job losses during a potential recession, as highlighted by Federal Reserve Bank of Chicago research. This slowdown is compounded by severe financial stress, with Equifax data showing small business loan delinquencies and defaults surpassing early pandemic highs. Furthermore, a persistent labor quality issue, with 81% of hiring firms reporting few qualified applicants, suggests that the recent quarter-point interest rate cut by the Federal Reserve may provide insufficient and delayed relief.

Key Decisions for Investors

• Given the rising probability of an economic pullback driven by weakness in the small business sector, investors should consider reducing exposure to U.S. domestic cyclicals and small-cap indices.
• Monitor small business credit stress indicators, such as loan delinquency rates, as a key forward-looking signal for the health of regional banks and the broader economy.
• The acute hiring struggles in construction, manufacturing, and transportation suggest potential capacity constraints and slowing growth, warranting a cautious stance on firms heavily reliant on these sectors.
• Recognize that the recent Federal Reserve rate cut is unlikely to provide immediate relief for small businesses, implying that underlying negative trends in hiring and credit may persist in the near term.