How Big a Bounce?
The middle market ended 2019 with a bounce back—partly back, at
least—from the worrisome performance we reported in the third quarter.
But is it back to business as usual? Does the middle market enter the
new decade boldly or anxiously?
Last quarter we said we would watch three things: whether revenue
growth and hiring rebound; whether investment activity increases or falls
further; and whether sentiment—confidence—continues its downward
path. All three have recovered. At the same time, all show continuing
signs of relative weakness.
Expansion
Take growth. Year-over-year revenue growth jumped from 5.8% to 7.5%.
That is below the 8% range we saw in the last couple of years, but it is
well above the historical average and consistent with the thesis that last
quarter was a one-time dip.
Growth projections, however, tell a less optimistic tale. Each quarter we
ask executives to report on last year’s growth and forecast what next
year’s will be. Middle market executives typically lowball these predictions.
As you can see, a year ago the middle market projected 5.9% growth
and delivered 7.5%. Worrisome here are not the absolute numbers in
the forecasts, but their direction—as the chart shows, there’s a slow
downward drift. It suggests that revenue growth in the next few quarters
will stay below the 8% numbers we saw in 2018 and the first half of 2019.
Employment growth projections show a similar declining trend line.
Furthermore, a growing number of executives say they will reduce their
workforce in the next three months. From an all-time low of 3% two
years ago, that number has slowly but steadily risen to 10%.
Investment
Investment plans are more bullish. The number of companies whose
plans for the year ahead included adding a new plant or facility,
introducing a new product, entering a new domestic market, entering a
new foreign market, and making an acquisition all dropped in the third
quarter. All look much better now. In particular, domestic expansion
plans are at an historic high; new product plans are near their peaks. But
international expansion remains low, probably because of the extra costs
and uncertainties of trade conflict. Both M&A and opening new plants,
while better than last quarter, are below typical levels.
One interpretation: Leaders are holding back on expansion plans that
require big, irrevocable commitments (new facilities, global markets,
acquisitions) while moving strongly ahead with plans that are easier to
trim or adjust (new products, new domestic markets). That interpretation
is consistent with what we see in the third dimension, confidence.
Confidence
Most confidence indicators have improved, suggesting that their slide
might have bottomed out in the 3rd quarter of 2019. One indicator: Last
quarter, 18% of executives cited “the economy” as one of their top
three long-term challenges—the highest we had seen in five years. That
number is now just 10%—tied for the lowest. Twenty-six percent expect
the business climate to improve, up from 17% three months ago; 11%
say it will be worse, down from 16%. And, asked what they would do if
they had an extra dollar, the number of executives who say they would
invest it jumped back up to 70%—a high number—after four quarters in
which it had declined, reaching just 56% three months ago.
But the caution bell still tolls. The most popular choice for a place to put
that extra dollar is information technology, picked by 18% of leaders. The
second most popular, at 17%, is to stash it as cash. That is, executives
are more likely to say they would put money into a rainy day fund than
into plant and equipment, new hiring, training, or facilities. It seems they
are not convinced that the economy will support their growth ambitions
and are holding cash in reserve in case they need it. Another sign of a
cooling economy: concern about costs, which had risen steadily from
2016 to the middle of 2018, when 26% cited costs among their top three
challenges; only 15% say so now—back exactly to where it was in the
first quarter of 2016.
It is important not to make too much of these notes of caution. They
are there; but the middle market’s dominant tune continues to be
optimistic, supported by a steady drumbeat of growth, hiring, innovation,
investment, and (increasingly) digital transformation.