Q3 2023 Middle Market Business Index

RESEARCH | September 21, 2023

Authored by RSM US LLP

The U.S. economy looks to be expanding in line with its long-term trend of 1.8% in the third quarter amid stabilizing prices, solid demand and a robust jobs market that presents a challenge to firms looking to grow. The RSM US Middle Market Business Index remained essentially unchanged, inching down to 129.3 in the current quarter from 131.1 in the prior period. 

One of the hallmarks of economic expansion over the past two years has been a divergence between current and future views of the economy. While the mid-market evaluation of the current economy remains dour—only 35% of respondents in the MMBI indicated that the economy improved in the current quarter—the view of the next six months is robust, with close to 60% expecting improvement.

Sifting through data on business sentiment across the real economy, we get the sense that the final adjustment to the inflation shock is now occurring, as overall growth in pricing has slowed to tolerable levels. Organizations’ evaluation of the current economy is still tempered by the permanent increase in prices of most goods and services. However, the forward look on the economy, revenues, earnings and even pricing remains rock solid, indicating the probability of a soft landing for the U.S. economy is rising following the twin shocks of inflation and higher interest rates.

Perhaps the strongest sign of support for this conjecture is the MMBI data on revenues and gross earnings. A solid 70% of survey respondents expect revenue to rise over the next six months, while 68% anticipate an improvement in net earnings over the same period. Based on this confident forward look, 63% of respondents expect to increase outlays on productivity-enhancing capital expenditures, consistent with a soft landing in the U.S. economy.

In contrast, during the current quarter, only 42% of respondents stated improvement in gross revenues, while just 40% saw a rise in net earnings. Just 42% said they increased capital spending.

Moreover, risks of an inventory correction appear to have abated; 39% of respondents increased inventories in the current quarter and 56% said they plan to boost them during the next two quarters. Should these trends hold, they will provide more evidence that the American economy will muddle though and avoid a recession. 

Recession probability is ebbing

Looking below the solid top-line business sentiment index and the sour evaluation of the current economy, the probability of a recession does appear to be ebbing as organizations adjust to higher pricing levels and get on with doing business.

The torrid pace of hiring that characterized the economy over the past two years is now gradually cooling in an orderly fashion, and MMBI data showed that this is true for midsize organizations. Roughly 38% of respondents indicated they increased hiring during the current quarter—down from 49% in the prior period. Sixty percent stated they intend to add workers in coming months. Forty-five percent said they boosted wages to attract labor and 68% expect to do so over the next half year.

We continue to note that the primary challenge to expansion for small and middle-sized firms is almost certainly finding able and willing employees to meet demand. Currently there are approximately 9.6 million jobs openings in the U.S., and only 5.2 million individuals actively looking for work. With 4 million people working part time for economic reasons, competition for labor is expected to remain intense, and companies will have to offer better compensation, benefits and workplace flexibility to attract that labor. 

Those labor costs that traditionally account for roughly 70% of all business costs are clearly being passed downstream in the form of higher prices. This was underscored by 70% of respondents who indicated they paid more for all goods and services in the current quarter, and 74% expect to do so in the near term.

However, the economy has clearly reached a point where firms are in the final phase of passing along those costs. Only 44% of MMBI survey participants indicated they raised prices in the current quarter, and 64% indicated they anticipate doing so over the next six months, down from 70% during the second quarter of this year and the cyclical peak of 77% in the third quarter of 2022.

UK MMBI posts dramatic jump

"The UK economy will resemble a seesaw over the next year. On one end will be the recovery in households’ real incomes, driven by falling inflation and a robust labour market. On the other side will be the impact of the huge surge in interest rates that have happened over the last year and a half. Over the rest of this year, the positive side is likely to win, meaning economic growth should improve in Q3 and Q4 after a moribund first half. But as we get into 2024, the negative impact of higher interest rates is likely to grow heavier. While we think the UK will avoid a recession, we’re expecting virtually no economic growth next year, meaning it wouldn’t take much to tip the balance of the economic seesaw into the favour of a recession"

Thomas Pugh, Economist, RSM UK Management Limited

Midsize companies look for a way forward on digital transformation, MMBI finds

Middle market company executives understand that digital transformation is an important objective, but they are not always backing up their ambitions with action, according to data from the second-quarter MMBI survey.

Almost three-quarters (74%) of all respondents say digital transformation—the large-scale realignment of business operations to take advantage of technology—is either the most important area or among the most important areas of investment for their companies. But a majority (54%) of all respondents say they either are way off from achieving their digital transformation goals or believe it is not relevant to their businesses to even begin a digital transformation program.