Middle market under pressure from trade wars, recession fears

Scott Schlange//January 14, 2020

Middle market under pressure from trade wars, recession fears

Scott Schlange//January 14, 2020

Scott Schlange

The new year is upon us and with it comes a 2020 election, along with uncertainty surrounding tariffs, trade and how long the economic expansion will continue. These items are all weighing on middle market business owners and C-Suite Executives as they plan for 2020 and beyond.

To understand what impact current macroeconomic conditions and government policies have on the business environment, KeyBank surveyed 400 owners and executives of middle market businesses, defined as those in the $10 million to $2 billion range. Here are the key findings:

Executives are feeling trepidation about what’s ahead

Warning bells are ringing for many middle market business leaders. Despite the overall strength of the economy, the federal government’s trade policy continues to send ripples of tension throughout the private sector. Middle market businesses are being riled by import and export tariffs, pointedly more so than last year at this time.

Meanwhile, economic growth is slowing after a record-long expansion. The gross domestic product growth rate hovered at an annual rate of 1.9 percent for the third quarter, falling short of the federal administration’s three percent goal. The data shows that while consumer spending remains robust, corporations are sharply pulling back.

Under pressure: U.S. trade policy in 2019

In an attempt to shrink a trade imbalance, curb intellectual property theft, and address other factors, the U.S. began imposing tariffs on China last year. In September 2019 the trade war heightened as a 15 percent tariff on $125 billion in Chinese imports was met with retaliatory tariffs from China on $75 billion in U.S. goods. Then, in October 2019, the U.S. broadened the trade war, setting tariffs on up to $7.5 billion of European goods including aircraft, food, and beverages. With more tariffs hitting on December 15, American businesses are bracing for impact.

Tariffs, volatility top the list of economic concerns

Tariffs topped the list of factors causing a poor outlook of the U.S. economy, according to two-thirds of respondents who had a good, fair or poor outlook of the economy. Following closely behind are the potential for an economic recession (63 percent), changes in trade agreements (62 percent), and a volatile political landscape (55 percent). These closely linked concerns suggest that executives are worried about macroeconomic factors that are outside their control.

When asked if tariffs are hurting their business, the answer is a resounding yes. In September 2019 nearly half of middle market leaders reported negative impacts from tariffs. At the same time last year, only 34 percent reported negative impact.

The sectors most affected by tariffs are automotive, technology, and agriculture. While the U.S. steel industry has benefited from the 25 percent tariff on steel imports and 10 percent tariff on aluminum, other industries that rely on those raw materials to build cars, housing, appliances, and/or infrastructure are suffering from the higher costs.

Middle market businesses curb investment, cut costs

Middle market companies are beginning to curtail investment. Commerce Department data in October showed business investment has declined for six straight months, falling three percent in the third quarter, the largest drop since the end of 2015. Supporting these figures, 69 percent of the surveyed middle market executives that are experiencing an adverse effect from the federal trade policy and the resulting economic uncertainty say they’ve reduced their business investment plans.

Taking a look at where firms are reducing investment, equipment purchases (61 percent of respondents), staffing expansions (43 percent), and facility renovations (43 percent) are bearing the brunt. Middle market business owners appear to be hunkering down for a recession by slowing expansion in favor of more critical operating needs.

In addition to restraining investment, firms are also implementing other cost-savings measures. A large share of the businesses surveyed have raised prices, reduced profit margins, or cut costs by using cheaper materials or components, trimming overhead, or reducing staffing.

And, as they did in 2018, nearly half of those negatively impacted by tariffs have passed the additional costs of tariffs along to their customers rather than absorbing them.

Recession warning bells are ringing

The economic expansion has surpassed 120 months—the longest on record—and many business owners fear the aging growth cycle, inverted yield curve, and rising federal deficit are signs of an impending downturn.

Executives also anticipate that consumer trends will soon turn, affecting corporate profitability. That’s because high consumer spending has been helping shore up economic growth even amidst declining business confidence and industry and government spending.

But now, consumers are beginning to feel the pinch of new tariffs targeting goods such as consumer electronics and specialty imported foods. While consumer spending stayed high through the holiday season, consumer confidence is gradually declining after reaching soaring levels a year ago. A commensurate decline in consumer spending could push the economy into a recession.

With all those issues at play, over half of middle market executives expect a downturn to occur within the next year. Nearly two-thirds anticipate it to have a negative or very negative impact. As a result, forward-looking middle market business leaders are now focusing on ways to improve operations and identify new revenue streams.

Business sentiment may be waning, but middle market owners and executives still have plenty of opportunity to set their businesses up for success. Whether your firm is interested in exploring mergers and acquisitions, payment automation, financing equipment, or changing your balance of liquid and long-term assets, it’s a good time to talk with your banker about everything from unique capital markets and advisory capabilities to customized working capital management capabilities and a variety of on- and off-balance sheet solutions.

Scott Schlange is the Commercial Banking Sales Leader with KeyBank in Idaho. He may be reached by phone at 208-364-8559 or email at [email protected]

This material is presented for informational purposes only and should not be construed as individual tax or financial advice. Please consult with legal, tax and/or financial advisors. KeyBank does not provide legal advice. ©2019 KeyCorp. KeyBank is Member FDIC. CFMA #101206 -707478