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Q4 2023 Middle Market Business Index: RSM US Index Jumps to 132.9, Driven by Booming Real Economy

by: Joe Brusuelas, Chief Economist
Joe Brusuelas
Joe Brusuelas
Reflecting the strong expansion and rising productivity in the American economy, the RSM US Middle Market Business Index (MMBI) increased to 132.9 in the fourth quarter, up from 129.6 in the previous period.

The index move, on top of 4.9 percent pace of growth in the third quarter, bolstered by a 4.7 percent increase in productivity, underscores the health of the U.S. middle market and an overall economy that we expect to grow at or above the long-term trend of 1.8 percent next year.

Productivity Surge Signals Bright Future
The major takeaway from the fourth-quarter survey, which asked senior executives of middle market businesses about their views on economic conditions, is that middle market firms expect to continue making productivity-enhancing capital investments to bolster output.

Those investments will create the conditions for improved revenues and net earnings, which strong majorities of middle market executives expect over the next six months, the survey found.

A plurality of the executives indicated that gross revenues and net earnings had improved during the current quarter, with 44 percent indicating better revenues and 41 percent noting improved earnings, in contrast with 32 percent and 37 percent indicating deterioration in those areas, respectively.

The executives’ outlook over the next six months was far more encouraging and constructive, with 72 percent anticipating strong revenues and 71 percent expecting improved net earnings.

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From our vantage point, the sharp jump in productivity over the past six to 12 months implies a much better outlook for corporate margins, which is a function of revenues and net earnings improvement.

We think this suggests improved corporate earnings ahead as pricing pressures ease and the past outlays on software, equipment, and intellectual property boost overall economic activity at a reduced cost.

One hallmark of the pandemic era that has continued into the current expansion is the willingness of middle market firms to make investments to boost productivity during a time when labor remains tight.

It is encouraging that despite an increased cost of doing business, 46 percent of middle market firms boosted outlays on capital expenditures and 66 percent intend to so over the next half year. This stands in contrast with the 20 percent of executives who said they pulled back and 9 percent who intend to do so.

In the survey, 26 percent said they increased borrowing to finance commercial and industrial loans and 49 percent said that they would do so during the next six months. Those figures align with recent Federal Reserve data pulled from its Senior Loan Officer Opinion Survey, which pointed to an improvement in demand for commercial and industrial loans despite elevated borrowing costs.

The sour mood on the economy among the MMBI survey executives improved somewhat, with 42 percent indicating an improvement in general economic conditions, up from 36 percent previously, while 39 percent said there was some deterioration in overall economic conditions. Still, 62 percent of survey respondents indicated they anticipate an improvement in economic conditions through the middle of next year.

We have made the case for some time that when it comes to the economy, one should watch what households and firms do and not necessarily what they say. It is of little surprise that firms continue to invest in their operations, hire more people, and lift overall compensation, as reflected in the current survey.

Approximately 44 percent of firms increased hiring during the quarter, and 66 percent intend to do so during the next 180 days. Roughly 52 percent of survey participants increased employee compensation, and 68 percent said they would do so in the near term.

During the first 10 months of the year, the economy added an average of 239,000 jobs per month (averaging 204,000 over the past three months), and compensation per hour worked has increased by 4.2 percent over the past year. While sentiment on the economy remains somewhat sour, it is simply not stopping middle market firms from expanding their operations.

Pricing is largely responsible for sour sentiment among the public and some firms. Middle market senior executives indicated that prices paid continue to increase, with 71 percent reporting they paid more for basic goods and 75 percent indicating they expect to continue paying more over the next six months. Nearly half, or 47 percent, of participants implied an increase in prices charged to firms downstream, and 66 percent said they would increase prices in the near term.

Middle market pricing power is one reason why firms remain optimistic about revenues and net earnings. American households continue spending amid strong employment, rising wages, and high savings. This is likely why 47 percent of survey respondents indicated they had increased inventory accumulation in the fourth quarter and 63 percent implied they will do so to meet underlying demand in the near term.

While inflation peaked at 9.1 percent in June of last year and has eased to 3.7 percent, we expect a slow decline to 2.5 percent by the end of next year, which will almost certainly continue to drag down firm estimates of general business conditions.

In addition, we urge firms to prepare for a pricing environment that will not reflect the 20 years before the pandemic, when inflation increased between 1.5 percent and 2 percent a year. We anticipate a business framework where inflation will increase between 2.5 percent and 3 percent annually, with the risk of a faster pace of rising prices on a permanent basis.

Remote Work Endures, Hiring Challenges Remain
The shift to remote and hybrid work, which began at the outset of the COVID-19 pandemic, has become a permanent fixture for some middle market companies three years later; meanwhile, retaining staff in a tight labor market marked by low unemployment presents ongoing challenges, RSM data shows.

Flexible work models in various forms at companies; 27 percent of executives surveyed in the fourth-quarter MMBI survey indicated they offer remote work options ranging from fully off-site to structured hybrid. Seventy-one percent said their firms require that all full-time work be done on-site have either no specific policy or offer an alternative. A greater share (33 percent) of smaller midsize firms — those with annual revenues of $10 million to $50 million — allow remote work, the MMBI survey found.

A majority of respondents whose firms have established flexible work models (60 percent) said the policies have had a positive impact on their organization’s culture, a change in sentiment from 39 percent a year ago. Twenty-four percent indicated the effect was neutral, and just 16 percent cited a negative impact. Reduced collaboration was seen as the biggest downside; 35 percent of companies with remote work arrangements said that factor had a major negative impact on the organization and another 36 percent said it contributed negatively in a minor way.

Meanwhile, while remote work policies are now established, executives' outlook about physical office space brings into question the longevity of those policies. Forty-six percent of respondents said their organizations are planning to increase their number of physical workspaces over the next two years, up from 25 percent a year ago. The percentage is even greater among executives at large firms ($50 million to $1 billion in annual revenues), up to 72 percent from 35 percent last year.

About the RSM US Middle Market Business Index
In partnership with the U.S. Chamber of Commerce, RSM US has collected data on middle market firms since 2015 through quarterly surveys conducted by The Harris Poll.

The RSM US Middle Market Business Index provides a leading measure on the performance of businesses that make up the heart and soul of the country's economy.

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