The North American stock markets have been steadily rising for over a month. Many of the major financial institutions are reporting a return to profits and an expectation that things are returning to normal.  Recent research by JP Morgan points out that most bear markets last, on average, 19-21 months and this bear market is on month 17. Is the recent rise in the fortunes of publicly traded companies a sign that the economy is recovering?

It could be. But, is the media focusing on the wrong source of where a true recovery will come from? Does the better sign of a true recovery reside in looking at the fate of  small and medium sized businesses (SME’s)?

Consider the following statistics:

• The U.S. government reports that 99.7% of all employer firms are businesses under 500 employees and employs about half of all private sector employees (in Canada, a 2003 study found about 55% of all employment is from SME’s which rises to over 60% if you exclude public sector workers).  If we assume that most of these firms are not publicly traded, it stands to reason that the majority of employers are private SME’s.
• Stats Canada found that a staggering 78% of all new net jobs in the period of 1983-2003 were created on the SME level (again, under 500 employees). The U.S. governments estimates SME’s are responsible for between 60%-80% of all new jobs. For example, in 2005, U.S. government data showed that businesses with under 500 employees create 78.9% of all new jobs (the consistency of Canada/US numbers at approximately 78% is quite errie). The conclusion? SME’s are over-overwhelmingly the source of new job creation.

Thus, while looking at broad based stock indexes may show how publicly-traded companies are doing, it may NOT be the best sign of whether a true economic recovery has began. It merely shows how a small segment of the overall economy is doing. If SME’s are the true job creators, and we assume job creation is a sign that the entire economy is turning for the positive and all the positive economic effects that result from a falling unemployment rate, the better place to determine whether a recovery is occurring is at the SME level.

Obviously, there is a multiplier effect when large publicly traded businesses expand and the interconnection between all businesses exists in a regulatory environment that has encouraged the free movement of capital. But, from a community perspective, publicly traded companies serve their shareholders and, as we saw during the apex of the out-sourcing fad, job creation on the publicly traded company level does not have the same localized effects as a SME expanding in your community. There is a better chance a local restaurateur who does well will spend it in the community over a large financial institution doing well.

We tend to fixate on the Dow Jones or the TSX 60 numbers simply because: (i) it is easy to obtain; (ii) most business columnist have high finance backgrounds, or their sources are in high finance, so they gravitate towards which they understand; and (iii) they tell us how our investments are doing.

However, a true recovery will occur when the local merchant feels confident not when the banker in his glass tower does. In other words, shop at your neighborhood merchant and not the big box store since you will see the effects more directly in your daily life.

I run a peroidic entrepreneurship column but Rick Spence devotes an entire blog on it (Seth Godin’s blog is also very good but with more a marketing spin). Check them both out.