Economy Recovering Slowly but Not So Surely

In spite of ongoing financial problems in Europe and an oil crisis in the Gulf of Mexico, U.S. financial executives believe that prospects for their firms continue to improve – though slowly. The 535 U.S. CFOs that we recently surveyed rated their optimism about the U.S. economy at 57.5 on a scale from 0 to 100, up from 55.5 last quarter. This is the highest reading of the Business Optimism Index since September 2007, indicating that the economy should continue to improve. We quickly add, however, that the Index still remains below the long-run average of 60. 

In other positive signs, over the next 12 months U.S. businesses plan to increase capital spending by 9%, tech spending by 6%, and marketing and R&D by 4%. They also expect earnings to grow by 12% over the next year. The big caveat, of course, is that these numbers are each starting relative to a low base level, so the increases are getting us back to where we should be, rather than an indication of robust economic recovery.

Employment will continue its positive trend, increasing by 0.7% in the next 12 months. Unfortunately, this rate of growth won’t put much of a dent in the number of unemployed. With a civilian workforce of about 153 million, 0.7% growth would add 1.1 million jobs over the next year – fewer than 100,000 per month. This is barely treading water when one considers natural growth in the working population. While it’s true that there may be nascent start-ups that will create additional jobs but are not yet part of our survey, we expect slow improvement in domestic employment. In fact, nearly 60% of CFOs tell us that they do not expect employment at their firms to return to pre-recession levels until 2012 or later.

On top of that, total take-home pay plus benefits lags for those still employed. Among companies that cut employment-related benefits during the recession, only about one-third have restored bonuses, overtime, training and development, pension contributions, or health benefits to pre-recession levels.

Like these other metrics, credit market conditions have improved, but not across the board. Twenty-four percent of U.S. companies say that credit avaliablibility has improved during 2010, but nearly as many (22%) say conditions have worsened. Among small companies, more than one-third say that during the last 12 months it has become harder for them to borrow. This is particularly troublesome for the economy because much job creation comes from small companies, and a lack of access to credit is still constraining their growth potential. In addition, during the recession one in four U.S. companies violated or nearly violated a credit line covenant. While the majority of firms were able to retain access to this important funding lifeline, it came at greater cost and with more stringent collateral requirements.

One other warning sign: for the first time since the start of the recession, health care costs have climbed back up the list of top CFO concerns, ranking as the fourth-most significant concern this quarter. U.S. companies expect health care costs to rise by 8% over the next year, gobbling up dollars that otherwise might have been used to reward employees with a long-awaited increase in pay. Our view is that this concern by CFOs reflects their uncertainty about the effects of health care reform.

While the U.S. business outlook is slowly improving (with caveats), the European outlook has taken a turn for the worse. Employment is expected to fall by 1.6 percent and corporate borrowing conditions continue to deteriorate. Interestingly, even though 80% of European business leaders say that the financial stability of Europe is severely threatened by Greece and other troubled economies, more than two-thirds of European CFOs agree that the stronger countries should financially support their weaker neighbors.

The best news from around the globe this quarter is that Asian CFOs expect strong growth in employment, capital spending, and earnings in the coming year.

Overall, we expect further economic improvement but anticipate that the recovery will continue to be slow and uneven.

John Graham is the D. Richard Mead Jr. Family Professor of Finance at DukeUniversity’s FuquaSchool of Business

Kate O’Sullivan is a Senior Editor at CFO Magazine

Each quarter the DukeUniversity / CFO Magazine Global Business Outlook Survey polls thousands of chief financial officers around the world. The most recent survey reflects the views of more than 1,100 CFOs in the U.S., Europe, and Asia. The survey has been conducted 57 consecutive quarters. The most recent survey contains much information not reported above. See http://www.cfosurvey.org for more details.