Middle Market Experiences Strong Economic Growth, Outlook Robust for Second Half of Year

The RSM US Middle Market Business Index (MMBI), presented by RSM US LLP (“RSM”) in partnership with the U.S. Chamber of Commerce, remains robust in the second quarter of 2018, with business leaders signaling strong positive forward-looking expectations on revenues, earnings, hiring and compensation. Still, their hesitancy to invest in capital expenditures remains intact, with just over half planning to increase spending in the quarter ahead.

In the second quarter of 2018, the MMBI posted a composite score of 134.5, a slight 2.2-point decrease from last quarter’s record-high 136.7. (A reading above 100 indicates an expanding middle market.) Middle market leaders’ optimism aligns with broader conditions, including the Fed’s recent interest rate increase, and an expectation that there will be additional increases later this year amid strong GDP growth and solid consumer spending.

“The middle market continues to fire on all cylinders, with 55 percent seeing economic improvement during the quarter,” said Joe Brusuelas, RSM US LLP chief economist. “In addition, 56 percent experienced increased revenues during the quarter and 69 percent expect to see further increases during the next six months. Yet this optimism is still not translating to investment decisions, as middle market leaders show hesitancy to increase spending on the technology and other capital to remain competitive in today’s market.”

Business leaders still appear to be holding back on important capital investments that would benefit their operations. Only 42 percent reported increasing capital investments, with 55 percent saying they are likely to increase in the next six months. These figures have been relatively unchanged for the past year even with improved revenues and earnings. Still, business leaders are indicating that they are going to continue to increase hiring and are seeing upward compensation pressures in the current tight labor market.

“We expect to continue to see optimism from middle market business leaders, and we are excited by the growth opportunities tax reform will have on their businesses and the broader economy,” said Neil Bradley, executive vice president and chief policy officer for the U.S. Chamber of Commerce. “Pro-growth policies like tax reform and deregulation make American businesses more competitive, improve cash flow, and encourage investment here at home.”

Capital Expenditure Plans Remain Unchanged, Even With Tax Reform
In Q1 2018, the middle market’s hesitancy to invest in capital emerged as a clear trend that continues into this quarter. Current perceptions and future expectations regarding capital expenditures are comparable to the levels observed in the first quarter.

In the context of the Tax Cuts and Jobs Act, middle market leaders are overall reluctant to increase business investments over the next three years. As a group, only 38 percent of the total middle market executives surveyed expect to increase outlays over the next three years.

“The middle market’s reticence to invest in their business, despite the tax reform stimulus, may be due in part to a lack of understanding on how certain provisions of the TCJA could benefit their companies and provide opportunities to accelerate capital expenditures,” Brusuelas said. “The survey results also indicate business leaders plan to spend more on attracting and retaining talent, yet could channel some resources to technology to improve productivity.”

Tight Labor Market Driving Employee Compensation Decisions
When it comes to cash flow, bigger businesses might have an advantage; executives in larger companies are more likely to say the new law will have a positive impact on after-tax cash flow than smaller companies (62 percent versus 46 percent). In general, top priorities for spending or investing the savings include shoring up the balance sheet and increasing capital investments.

Not surprisingly, 54 percent of middle market respondents indicate further reductions in the corporate tax rate would improve growth conditions. Of the cohort familiar with the tax cut that expect it to have a strong impact on their after tax cash flow, 62 percent intend to increase hiring, 65 percent to increase compensation and 54 percent expect to give a one-time bonus or payment to labor – consistent with survey data indicating a lack of available labor as the top issue facing middle market businesses.

Additionally, when it comes to cash flow, bigger businesses might have an advantage; executives in larger companies are more likely to say the new law will have a positive impact on after-tax cash flow than smaller companies (62 percent versus 46 percent). In general, top priorities for spending or investing the savings include shoring up the balance sheet and increasing capital investments.

The survey data that informs the index reading was gathered between April 12 and April 30, 2018. To learn more about the middle market and the MMBI, visit the RSM website.