An Optimistic Middle Market Indicates an Economic Rebound

2Q Middle Market Indicator Perspective

 

It appears the lasting effects of the Great Recession, officially from 2007 to 2009 but followed by many years of disappointingly low GDP growth, may finally be coming to an end. According to the Conference Board, consumer confidence in June was the highest in over five years. The Department of Commerce reports that new home sales in May were the highest since July 2008 and based on the S&P/Case Shiller Index, home prices hit the largest annualized gain in seven years in April. Durable goods orders and business spending are also remarkably up, also according to the Department of Commerce. Overall, the Federal Reserve is now forecasting real GDP growth up to 2.6% this year, with further expansion up to 3.5% in 2014. But, what will continue to drive this improvement?

Exports appear to be an unlikely source of growth. The Eurozone has contracted for the sixth consecutive quarter and China, the world's second largest economy, is slowing down, evidenced by manufacturing activity there contracting for the second month in a row. More ominously, Beijing is trying to constrain overly easy credit from banks, which may produce a credit crunch and dampen growth.

On the domestic front, the projected rate of revenue growth for large firms remains low at 1.2%, according to Bloomberg. There are signs that small firms are lagging in the economic expansion as well. In fact, confidence among small firms remains at recessionary levels, according to an article by Bloomberg.

It will come as no surprise to those who follow the middle market as to the engine behind this recovery. In the latest survey from the National Center for the Middle Market, the middle market continued to grow revenues at a healthy 5.8% in the last 12 months, and is expected to grow at 5.1% in the coming year.  Employment in the middle market grew at 2.6%, and is expected to grow at 2.5% in the next 12 months. Economic confidence at all levels - global, national, and local - were the highest among the six quarterly surveys to date. The largest proportion of middle market managers in our six surveys (64%) would invest if given an extra dollar. Relative to other segments, these indicators are consistent with the middle market as the front runner of the recovery.

A new challenge for the middle market: A possible credit crunch

Unfortunately, a number of challenges put the middle market and the economic recovery at risk. The latest problem to emerge is the likely return of costly credit. Recently, Fed Chairman Ben Bernanke commented that the "taper off" of quantitative easing would begin from December 2013 and end by mid-2014. The Chairman's remarks had an immediate market effect, as rates on 10-year Treasuries spiked to a two-year high, and the stock market dropped significantly. Middle market firms in particular are adversely affected by tight credit markets. They have neither government subsidized schemes or the influence of large firms to command more affordable credit. Although the Fed faces an understandable dilemma, it might reconsider its position and remove the stimulus only after the economic recovery is firmly in place.

A long-standing top concern for the middle market: Healthcare costs

There are other long-standing problems that hinder growth in the middle market, healthcare costs in particular. Healthcare costs have been consistently ranked as the top challenge for middle market managers in every quarterly survey since the beginning of 2012. In past surveys, it was pointed out that the Patient Protection and Affordable Care Act (PCACA, but popularly called Obamacare) may have some unintended negative business consequences. Middle market managers have said that higher healthcare costs will dampen investment and reduce employment. Now, through follow-up investigation, we further know that the managers who worry about adverse effects of healthcare reform also predict lower revenue growth rates. Such managers also report lower confidence at all levels: global, U.S., and local economies. The recently announced delay in the enforcement of a major PCACA requirement that all employers with more than 50 employees provide coverage to their workers means more companies will have time to consider the best strategies for implementation.

So, what can middle market firms do to spur growth?

With relatively little influence on government policy, middle market firms have had to historically "grin and bear it" when it comes to the consequences of government action. In contrast, small firms have formal advocacy in the form of the Small Business Administration, and large firms have greater resources to support lobbying efforts and other measures. There are, however, other avenues for middle market firms to drive growth and The National Center for the Middle Market has been highlighting such strategies for growth. In its research on the characteristics of so-called Growth Champions (firms with sustained 10% revenue growth), globalization has emerged as an effective path toward increasing revenues as well as employment. The latest MMI survey findings show that middle market firms with some international operations (606 respondents) are projecting revenue growth for the next 12 months at 5.6%, while those with operations entirely within the U.S. (394 respondents) are expecting an average revenue growth rate of 4.3%. In terms of employment projections, the corresponding rates of growth are 2.7% versus 2.3%, respectively. The recent experience over the last 12 months, in terms of both revenue and employment growth, also shows greater growth among firms with international operations. This is particularly impressive in light of economic challenges in Europe and China.

The U.S. economy is finally in a meaningful recovery mode, and middle market firms are major players in this recovery. Research from the National Center for the Middle Market offers prescriptive strategies for growth. In fact, these strategies do not depend on being in certain industries or geographies. Rather, they depend on the actions of the firm. Specifically, organizations with superior customer focus, management culture, talent management, investment in innovation, and geographic expansion have demonstrated sustained high growth in the past, and should be poised for future success.

Download the 2Q 2013 Middle Market Indicator.


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