Transcript
Speaker: The US economy has grown for 120 straight months, the longest expansion on record. And in the last seven years, revenue at the average middle market company has grown at a 6 .9 % annual rate. Can it keep going? Welcome to The Market That Moves America, a podcast from the National Center for the Middle Market, which will educate you about the challenges facing mid -sized companies and help you take advantage of new opportunities.
Speaker: The US economy has grown for 120 straight months. It's the longest expansion on record. And in the last eight years, revenue for the average middle market company has grown at a 6 -7 % annual rate.
Speaker: Can that keep going? I'm Tom Stewart. I'm the executive director of the National Center for the Middle Market at the Ohio State University Fisher College of Business. We're the nation's leading research group studying mid -sized companies, which account for a third of private sector employment and GDP and the lion's share of economic growth.
Speaker: It is indeed the market that moves America. The National Center for the Middle Market is a partnership between Ohio State and Chubb. Today, I'm happy to welcome back Dan North. Dan is the Chief Economist of Euler Hermes, the insurance company that specializes in trade finance.
Speaker: Dan and I are joined by Doug Ferren, who's the Managing Director of the National Center for the Middle Market. Dan, you've been with us each of the last two years to talk about the economy, and we're delighted to have you back. Well, thank you so much for having me back. It's always a pleasure to be here.
Speaker: But Dan, maybe we should start with this sort of overall big picture. From an economic point of view, how is business? I mean, Euler Hermes ensures trade receivables and the like. Can you tell us a little bit about that and the kind of insight that that gives you about the state of the economy?
Speaker: Sure, well, as you know, we ensure our clients against non -payment. That is, when they sell goods to another business, they run the risk that that other business could possibly go bankrupt before they have an opportunity to get to pay our clients back. So, a brief way of putting it is we protect our clients against getting stiffed. Now, as part of the policy, all of our clients tell us every month
Speaker: Who is paying them late? How much they're behind? For how long? And this gives us a really good right on the front lines indicator of what's going on in the economy and in the middle market. And it turns out
Speaker: that when you look at our past due reports, this is like two or three thousand data points every month, pretty strong leading indicator of the economy, and last year our past due reports were up very, very substantially.
Speaker: indicating quite likely a sharp slowdown in 2020. Now, let me just guess that if you look inside these things, are most of these people who are falling behind smaller companies or are they just bigger companies hanging back? I mean, in the composition of these late payers, is there anything interesting in there?
Speaker: Well, it's through all sizes. So for instance, a lot of our clients might sell goods to Walmart. Well, Walmart's not a bad credit and it's not going to go bankrupt. But Walmart does pay slowly because they can. But a lot of our clients sell to smaller businesses and that's where we're seeing the financial stress. Doug, you want to ask Probat a little bit?
Speaker: Yeah, so certainly Dan, great to have you back. We heard you today at a presentation for the Association for Corporate Growth, the Columbus chapter here in town. In addition to some of these kind of basically defaults and trade issues, you also shared a number of different economic indicators.
Speaker: Could you share some of those highlights and maybe talk a little bit about what they mean for the coming year and maybe even answer the million dollar question, which is, do you see a recession coming?
Speaker: Well, I think the answer to that is the probability of recession is low, but it's not zero. So if you look at something like a consensus survey, economists might say, oh, there's a 25 % or 20 % chance of a recession. Well, either way, they're wrong. Because if there is a recession, they were 80 % wrong, and if there isn't, they're 20 % wrong.
Speaker: The probability is sort of academic. I think a better way to put it is we think that it's a less likely scenario, but the much more likely scenario is one of quite slow growth this year. So for instance, 2018 GDP growth was 2 .9%. That's probably as good as it's gonna get given our demographics. Last year in 2019 was probably around 2 .4%.
Speaker: We're dropping to 1 .6 % this year. Almost a 50 % drop. Yeah. It's a pretty sharp slowdown and the trouble you run into, it's like an airplane. When you're that close to the ground and you run into a little problem, you're much more likely to hit the ground. So there's much less buffer when we're growing that slowly.
Speaker: And there's a number of factors driving that, so I know you had mentioned earlier this morning the economic stimulus is basically gone, right? There's no more of that. That's right. So if you think about it, the government has two major tools it can use to stimulate the economy. One is fiscal policy, which is a matter of taxing and spending. So we had fiscal stimulus in the Tax Act of 2018, which provided
Speaker: a tax cut both to individuals and to corporations. Well, that's fiscal stimulus. You get more after -tax income to consumers, and so they spend a little more. And that was very helpful for a year.
Speaker: But that's just a break for a year. We're not getting another tax cut this year. So suddenly your after -tax income starts growing at a more normal rate. You're not getting a boost. You're not getting fiscal stimulus. And if that's one of your major tools and it's dried up to nothing, well, that's a drag on the economy. The same thing
Speaker: On the corporate side, we got a corporate tax break and that showed up into stronger corporate profits. Well, guess what? Corporate profits are now down to zero percent growth year over year. So that fiscal stimulus, which really helped for a little while, is gone now.
Speaker: And what about the other stimulus, I guess a monetary stimulus, which is the rate of interest and how much the cost of capital is, and where are we in terms of monetary stimulus? Correct. Well, that's where it gets slightly trickier because when the Federal Reserve takes a monetary policy action such as raising or cutting interest rates,
Speaker: It takes a full year for that action to be fed all the way through the economy. So we've gotten some interest rate cuts in the past year. That's going to take a while to flow through the economy.
Speaker: And really where it's gotten a little bit trickier is monetary policy, where we came from. We came from a position where we've never been before, which was 0 % interest rates and massive monetary policy, quantitative easing, basically virtual money printing. The problem is when you have that much easy money, 0 % interest rates for so long, it's very hard to back out of that position.
Speaker: If we look at the increase in interest rates that the Federal Reserve undertook, it's actually quite a large increase when we look at what's called the shadow Fed funds rate. It gives us an idea of what the Fed funds rate actually is or effectively is when the bound is zero. It's a little bit technical, but the point is
Speaker: The Federal Reserve has tightened quite a bit, and I think that is still very much a drag on the economy. The most recent cuts will stimulate, but it's going to take a while. So fiscal policy is dried up, monetary policy I still think could be a drag at this point, and that's a pretty tough combination. And we've also got trade policy creating a headwind, too. So you've got these two tailwinds that are weaker wobbly and a headwind that
Speaker: How much of a headwind is trade policy in tariffs? Well, you know, so far it hasn't been that dramatic. And here's why. You know, we're in a tit -for -tat trade battle with China on tariffs.
Speaker: So the concern was when we put on tariffs to Chinese goods in coming to this country, that it would raise the prices and be a damper on economic growth. Well, it really hasn't because, number one, the Chinese devalued the yuan, which kind of makes it easier to eat those tariff increases. And corporations ate a bit of those tariff increases. They're the ones that actually have to pay the tariffs.
Speaker: So corporate margins got eroded, which is one of the reasons corporate profits are now down to zero. And not much got passed on to consumers yet. The tariffs that are in place now cost the average family like seven or eight hundred dollars a year. It's not been a big, big impact.
Speaker: It could be a big impact. We just signed that phase deal one yesterday, but that sort of thing can fall apart. And if we put in the last tariffs on the last bit of Chinese imports, that's consumer goods.
Speaker: That's iPads and phones and apparel and electronics. That really will hurt the consumer. But so far, they really haven't made a big impact on the consumer, have hurt corporate profits, and certainly have been a pressure on manufacturing. We see manufacturers really in recession.
Speaker: So earlier you said that a Fed action takes a year to work through the economy. If the impact of tariffs is hitting corporations now, is it possible that it's just a lag and that that will set 700 bucks a year for a typical family, which depending on your income is not, of course I assume that varies by median income, but could that number be rising as corporations decide they're not gonna,
Speaker: take that in their margins anymore and start passing it on? It may absolutely be the case because I think you see margins really eroding pretty dramatically and corporations can only take that for so long and then there will be pricing pressure. They are going to have to pass those on or they're going to start facing serious consequences eventually moving towards going out of business. So those prices, tariff increases will have to be passed on for sure.
Speaker: And then as those tariffs start to hit more consumer goods, will we see that reflected in shrinking consumer confidence? Is that where you'd most likely see that reflected?
Speaker: I think surely you will see a downdraft in consumer confidence and I just think that you are going to see a downdraft in consumer spending as well. If you look at a consumer confidence survey, the conference board survey is the big one, it's split into different parts and part of it is how consumers feel about the current situation, part of it is how they feel about the future.
Speaker: Well, it turns out consumers' feelings about the future are way worse than they are now. When you get that big a spread that as consumers become that much more concerned about the future, they're usually right, and it's almost always associated with the recession.
Speaker: So unlike past years where we've talked with you, Dan, we're in an election year. And with that brings its own level of uncertainty. So can you talk to us a little bit about how the upcoming election will impact some of these indicators? Well, handicapping politics is a lot harder than handicapping the economy, which is pretty hard anyway. So I'll have to step out on a limb here a little bit.
Speaker: One thing we notice is that the impeachment proceedings and even the Mueller investigation have had virtually no effect on the economy and certainly not on the financial markets. And this was the same thing we saw during the Clinton era. We went through an impeachment and a trial and the economy and the stock market never even blinked.
Speaker: And I think that's what we've got now. And it's quite obvious that in the Senate, when we go to the Senate trial, Trump's certainly going to be acquitted because to find him guilty, about half of the Republican senators would have to defect. And that's just not going to happen.
Speaker: So I think there's not that much uncertainty there. You'll see some more uncertainty, I think, around who the Democratic nominee is going to be. That's going to be, I think, a more difficult choice, and you'll see a bit more of uncertainty around that. What you will see that's certain around the elections is we will not get any fiscal stimulus.
Speaker: What I mean is Trump can run on the idea that the economy is great. I did it, by the way. And, you know... You touched yourself. I realize you're saying that you, Dan North, did it, right? No, please, take it. And he's got a good point. The economy has done pretty well. And the unemployment rate's super low and so forth.
Speaker: Democrats will do anything, I think, to derail it. So the last thing they're going to do is help him. That is, help him in terms of a fiscal stimulus, either tax cuts or extra spending. That's just not going to happen. We're going to be pretty certain about that. After the election's over, I think no matter who's in power, the spending is going to come back online. So you will get fiscal stimulus after that, not beforehand.
Speaker: So one of the things I think about is I'm trying to put myself in the position of a middle market executive team. Got some financial resources, but my pockets aren't all that deep. And I've been growing pretty fast. I need to hire people, and I need to invest capital to grow. I'm trying to think, what's the environment in which I will be making
Speaker: those decisions. I know you're a macro economist and not a micro economist, but if I'm imagining you coming in and saying, okay guys, here's the environment, here's the picture in which you should be making these plans. You're feeling pretty good. You want to expand.
Speaker: And so I'm looking around saying, how aggressive should I be or how much of a rainy day fund should I keep? What's that kind of conversation or tenor in that room or the insight that you would bring into that room from the economy?
Speaker: Well, I think what we're looking at here is 2020 being a much slower and therefore from our business, a much riskier year. We've already seen that in our claims behavior. When small and medium sized enterprises are put under financial stress, they're much more likely to go under or start paying more slowly.
Speaker: So you have to look at it in terms of a risky year. Now, it's slow, but it's not zero. We're not saying recession. So demand is good. This has been, you know, supposedly a stronger economy than in the previous administration. Certainly it's growing.
Speaker: So it's a tough choice. You would continue to grow while you can, but understand that there's risk out there and maybe that risk takes the form or your actions against that risk might take the form of, I'm hiring people, maybe I want to slow down. Maybe I don't need to hire quite as many people as I've done. In fact, that's what the macro data is showing is hiring is in fact slowing down.
Speaker: From our risk point of view, we see warning signs when companies start saying to other companies, yeah, I'll pay you back, but I need a few more days. Or can you give me a bigger credit line, because I want to be able to buy more from you before I go bankrupt? These are the kind of warning signs that we see, and at that point, maybe you start reducing your risk profile. So our middle market indicator for the first quarter shows
Speaker: Pretty much steady as she goes in pretty robust new product introductions and new domestic market expansion, but a little bit of drawing back on hiring, international expansion, plant and equipment, and M &A, all of which are sort of
Speaker: more irrevocable decisions for the others you can fine -tune. These others are sort of binary, your in or your out commitments. We're seeing a little bit of holding back, which would resonate with what you're just saying there. Well, I'm glad that we're on agreement on that one.
Speaker: So are there any other issues, Dan, that you think mid -sized companies should be thinking about given this environment? So some of the things you just mentioned are dealing with suppliers or maybe even your own internal workforce. But I'm thinking about areas like your customers are working with your lenders, capital expenditures, things like that.
Speaker: Yeah, there are always a number of considerations. For instance, right now, financial conditions, by any number of measures, are really very easy. Interest rates are very low. Interest rate spreads are very low. Stock market's very strong. So that's a great environment. We know that that can back up pretty easily.
Speaker: So that is certainly something to be wary of. I mean, interest rates are notoriously difficult to forecast. Nobody saw the 10 -year rate going up 50 basis points over the course of a month or two. But those kinds of things can certainly happen and they're certainly worth keeping an eye on.
Speaker: Another thing to think about is the trade situation. Okay, so we signed a deal yesterday. It isn't a total nothing burger. There is some good stuff in there. Suppose the Chinese are going to buy another $200 billion worth of US goods over the next two years.
Speaker: Well, that's a pretty big problem because it would require a 50 % increase in purchases from the Chinese, and that seems pretty unlikely. And there were some very vague promises about not going into IP theft anymore and that sort of thing.
Speaker: You know, there was something there, but there was substantive, but not a lot. Phase two is something that we want to look for, but honestly, I don't see that until after the election. But any kind of trade developments, for instance, next month, we're supposed to put 100 % tariff on goods coming in from France.
Speaker: Well, that may or may not happen and will really affect a lot of the particular markets. So developments in global trade are surely worth watching. As I mentioned before, watching who gets paid back on time and what the excuses are that are coming in. Oh, my guy didn't pay me so I can't pay you. That's the kind of thing we hear once in a while that is a real risk.
Speaker: What about the upside? Economists, of course, are famously two -handed, and Harry Truman said he wanted a one -handed economist, so he didn't hear on the one hand and on the other hand. Could there be positive surprises coming up? Oh, sure. I'm absolutely a one -handed guy.
Speaker: I'm telling you that the economy is going to grow slowly and that there's a risk of maybe a 0 % quarter somewhere in there. And on the same hand, I'm telling you that I think we'll see continued growth through next year. So there's no equivocation there. We just see this year as a bit riskier there.
Speaker: There are certainly some other things that could help. Again, after the election, the fiscal policy, they already started talking about that. I think two days ago, Larry Kudlow came out and said, yeah, we're going to have the tax cut around 2 .0 after the election.
Speaker: So policies along those lines. We could see some more Fed rate cuts. We expect to see one more this year even. And we could see even more of those the following year. So you could see those two major stimulus tools helping. You could see reductions in tariffs across the board. That would be helpful for the whole global economy.
Speaker: and help boost global trade, which of course would be favorable to everybody. Those are the kinds of things that I think could really be positive. And there's no reason to think that we're definitively going to spiral down and not be able to come out of it. It's to say, you know, slow growth, a positive outlook with lots of risk there.
Speaker: So trying to wrap that up, I mean, if I were smart enough, I could say one hand but five fingers and I could make five wrap up points here, but I'm not gonna do that. But you sort of think, what you just said, slow growth, a prediction of 1 .6 % GDP growth for the US overall, a really benign, seemingly benign cost of capital credit market, interest rates are gonna stay low, so capital's not gonna be expensive. But at the same time, a fair amount of
Speaker: resistance to more expansion, little stimulus, trade barriers, and other things. And so, as you said for middle market executives, the advice is sort of steady as you go, keep your eyes open, don't get out over your skis, be very cautious, but don't be terrified. And I think that probably, don't be overlaying, don't be overlaying. Does that pretty well summarize it? Are you reading from my notes?
Speaker: It's glad to see that great minds think alike, but they also say that fools think alike too. So let's hope that we're the former. I have one last point. I often talk about the disconnection between the stock market and the economy. I get a lot of pushback because people are saying, God, the stock market was up 30 % last year. My 401K is fantastic. What are you talking about a slowdown? You're nuts.
Speaker: And historically, if you go through the stock market, it gives you very little warning, typically, of a slowdown. So there's definitely a disconnect. I would say this time, however, because there's so much euphoria in the stock market and so little of it was built on earnings last year, that is on economic performance,
Speaker: I think you've got a lot of froth there, and given everything else that we're looking at where there's potential risk, if you see a blowoff there, that could be damaging to the economy this time.
Speaker: Okay, well thank you. Dan North, the chief economist of Euler -Hermes in the United States, with his view, now in a tradition for us at the National Center for the Middle Market, his view of where the U .S. economy is going. For more about Dan and Euler -Hermes' work, you can check out their website, which is eulerhermes .us.
Speaker: and thank you for listening to The Market That Moves America. Never miss a new episode. You can subscribe to the podcast on iTunes, Stitcher, Google Play, or wherever fine podcasts can be found. Or you can subscribe and learn more about us at the National Center for the Middle Market at our website, which is middlemarketcenter .org.
