Optimism dips as lawmakers struggle to legislate
“The real economy sent a message in the third quarter: We are losing confidence and may begin pulling back on plans to hire, raise compensation and increase capital expenditures due to the lack of progress on substantial policy reform.”
So begins the summary of RSM Chief Economist Joe Brusuelas on his organization’s most recent index of middle market confidence. The topline number of the RSM U.S. Middle Market Business Index (MMBI) —an assessment of 700 middle market executives’ confidence in the economy—declined by 6.4 points to 125.7 from last quarter’s all-time high of 132.1.
RSM is the world’s sixth-largest audit, tax and consulting network, with a global fee income of $4.87 billion in 2016. The index has always been conducted in partnership with Moody’s Analytics, and earlier this year it gained another partner in the U.S. Chamber of Commerce.
Since debuting at 116.6 last year, the MMBI has averaged well over 100, which is the baseline number for neutral outlook. That means that for the last year and a half, respondents viewed the economy in a positive light, and continue to do so today, albeit with less enthusiasm. The latest report is the first time in four quarters that the index has dropped.
Brusuelas believes the decrease is due to a sentiment that became overly optimistic after last year’s elections, which resulted in single-party control of the executive and legislative branches for the first time since 2010. The assumption, Brusuelas says, was that unity between Congress and the White House would enable major legislation, particularly in the areas of health care, tax reform, immigration and infrastructure spending.
That hasn’t been the case. After ten months, the new government has little progress to show toward its declared agenda. Multiple attempts to reform the Affordable Care and Patient Protection Act have fallen short. When asked which existing policies were having a negative impact on business, most MMBI respondents point to health care.
President Donald Trump and Congress are also attempting a historic rewrite of the U.S. Tax Code—a project still in its early stages. Taxes were the second-most reported policy area negatively affecting mid-market organizations, according to the survey, and failure to act on these priorities could push the MMBI lower. The report warns that the index could dip to around 120 by the next iteration, with the stage set for additional declines that could generate tangible negative effects beyond internalized pessimism.
“[Right now] the middle market is outperforming the Fortune 1,000,” Brusuelas says. “Small and medium enterprises are responsible for more than 70% of the hiring. However, you see a misalignment of optimism following the election due to the enduring political polarization and the political realities of our current times. I am somewhat concerned that should the political authorities fail in their attempts to reform the tax system, the health care system or engage in substantial infrastructure spending, you could see expectations pull back more noticeably and create conditions where it spills over into hiring, compensation, inventory building and capital expenditures. We are late in the business cycle and this is when these optimism surveys tend to be the most important.”
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The impact of waning optimism can already be felt in tightened borrowing. There was a seven-point drop in the number of respondents who are planning to borrow, compared to last quarter. Also dropping are perceptions about future economic activity. Seventeen percent of respondents think the economy is worsening and 19% of respondents expect it to shrink in the future. The report highlights both numbers as significantly higher now versus the prior survey. Overall, gross revenue performed the same as the previous quarter, while net revenue declined slightly.
The situation may be more dire than these numbers reflect, as Brusuelas notes data were gathered before the violent protests in Charlottesville, Virginia, sparked national outrage and engulfed the presidency for a number of weeks. The report also doesn’t take into account the effects of three major hurricanes wreaking havoc on wide swaths of U.S. territory, which Brusuelas says might impact upcoming indices. Nor does it include recent actions of the Federal Reserve, which announced it will begin to slow the reinvestment of maturing proceeds of investments bought in the past.
“It’s entirely consistent that you can have an economy chugging along at 2% to 2.5% while optimism adjusts back to a steady level following the inflated optimism of the election, when for a brief period of time, our survey participants thought that significant reforms would get done,” Brusuelas says. “What we’re seeing is the paring back of that optimism given seven months of lack of reform or substantial achievement.”
MMBI numbers are decidedly more pessimistic than results of the National Center For the Middle Market’s 2017 Middle Market Indicator. That analysis, which covers the same period as RSM’s index, found that middle market revenue growth over the past 12 months clocked in at 6.7%, down from 9.2% in the previous indicator. Furthermore, the NCMM reports that confidence in global, national and local economies remains historically high, and its own short-term index, derived from “executives’ view of the business climate, sales and demand over the next three months” is down slightly from the last quarter but still 20 points higher than in 2016.
Shortly after the RSM Q3 report was released on September 19, Brusuelas flew to Washington to discuss results on Capitol Hill with members of Congress and cabinet officials.
“The middle market constitutes 40% of the GDP and one-third of the labor force. [The MMBI] gives them a sense of what’s happening on main street,” Brusuelas says. “When I was up on the hill, at the think tanks and the agencies, they got the message. They know they have to succeed. … There is enormous pressure inside Washington right now to get something done of substance. Anything.”
Rep. Steve Stivers, R-Ohio , one of four co-chairs of the Congressional Caucus for Middle Market Growth, agrees with that assessment. “There is no doubt that all businesses—including middle market companies—are in need of regulatory reform and tax relief,” he said via e-mail. “That’s why at the beginning of the year, the 115th Congress prioritized cutting red tape and reducing many of the onerous regulations on businesses. Now, we feel the urgency to reform the outdated tax code, and [on September 28], a framework was released for comprehensive tax reform. This framework includes policies such as a maximum tax rate of 25% for S corporations.”
Stivers added that, “I believe Congress can get tax reform done. Updating the tax code will unleash our economy, allowing all businesses to grow, thrive and create more jobs in our communities.” The other three caucus co-chairs, Rep. Jared Polis, D-Colo., Rep. Kyrsten Sinema, D-Ariz., and Rep. Tom Rice, R-S.C., did not respond to requests for comment.
Brusuelas reported that policymakers are particularly interested in responses pertaining to this edition’s topical survey questions, which contain insights unique to each survey. Improvements to America’s telecommunications network and interstate highways garnered the biggest consensus of the 20 infrastructure categories with 72% of respondents saying they see business opportunity there. Fifty-nine percent of respondents that ranked more than one category as a significant opportunity also say they would participate in a bidding process to receive government contracts to perform the upgrades.
The upshot is that many middle market executives anticipate direct and indirect windfalls from the passage of a mammoth infrastructure bill, once purported to total $1 trillion. It’s another reason for the government to deliver, and another cause of middle market frustration if it doesn’t.
Zach Brooke is a former AMA staff writer turned freelance journalist. His work has been featured in Chicago magazine, Milwaukee Magazine, A.V. Club and VICE, among others. Follow him on Twitter @Zach_Brooke.