The Economy

CFO Optimism at a Three-Year Low

In addition to concerns about the costs of health care and fuel, finance chiefs maintain that ''the next volley of rate increases will do some dama...
CFO StaffJune 2, 2005

Capital spending and employment growth will slow during the next year, according to a new survey of chief financial officers, who point to high costs of health care and fuel, rising interest rates, and reduced pricing power.

These are some of the findings of the June 2005 Duke University/CFO magazine Business Outlook Survey, which asks chief financial officers from a broad range of public and private companies worldwide about their economic projections. This latest quarterly survey was concluded May 30 and generated responses from 602 CFOs, including 365 from the United States, 153 from Asia and 84 from Europe. (Results cited here are for U.S. companies unless explicitly stated otherwise.) Detailed results are available at www.cfosurvey.org.

This quarter, 40 percent of U.S. finance chiefs say they are more optimistic about the economy than they were last quarter, while 26 percent are less optimistic. This continues the downward trend in optimism over the past year: 46 percent were more optimistic last quarter, 54 percent were more optimistic two quarters ago, and more than 70 percent were more optimistic a year ago.

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“This is a new low for CFO optimism,” said John Graham, professor of finance at Duke’s Fuqua School of Business and director of the survey. “We’ve found that this optimism index predicts future economic growth quite well. In a situation like this, where the optimists barely outweigh the pessimists, we can expect to see sluggish economic growth.”

Asian CFOs share the same muted optimism. “In contrast, European CFOs are explicitly pessimistic,” Graham said. About half of European finance chiefs are more pessimistic about their national economies than they were last quarter, he added; only 16 percent are more optimistic.

In the United States, where finance chiefs expect health-care costs to rise nearly 9 percent in the coming year, nearly 40 percent of survey respondents cited those costs as a major issue for their companies. High fuel prices, increased interest rates, and reduced pricing power are other major concerns.

U.S. finance chiefs also maintain that “the next volley of rate increases will do some damage to GDP growth,” said Duke finance professor Campbell R. Harvey, founding director of the survey. A federal funds rate of 4 percent will slow U.S. economic growth, according to 83.2 percent of respondents; 43 percent say that increased interest rates will slow growth at their own companies, too. “The easy part of the Fed strategy is over; the next phase will take a bite out of investment and employment plans,” said Harvey.

Partly due to higher interest rates, corporate executives are reducing their capital spending plans. Although two-thirds of respondents say they will increase capital spending in the next 12 months, they also say that the increase will average only 4.5 percent, compared with 5.4 percent last quarter. “This rate of capital spending increase is barely sufficient to replace depreciated assets,” noted Don Durfee, research editor of CFO magazine.

“On the bright side, we expect to see a 10 percent increase in earnings next year,” added Durfee; that’s down only slightly from the 10.4 expected as of last quarter.

Price increases at U.S. companies are expected to average 2.1 percent next year, up slightly from the 1.95 percent increase that survey respondents anticipated last quarter. This low level of price inflation reflects the difficulty of raising prices in a highly competitive economy — even as input costs are increasing, putting the squeeze on corporate profits.

In addition to the rising cost of health care, 53 percent of U.S. chief financial officers say that rising costs for energy and raw materials are the main reason that companies feel the need to increase prices; 18 percent cite labor as a factor in higher input costs.

Domestic employment is expected to increase by 1.4 percent this year; in last quarter’s survey, that figure was 1.7 percent. For the third quarter of 2005, 43 percent of companies say they will increase employment by a small amount, 16 percent by a moderate amount, and only 2 percent by a large amount. Employment growth is expected to slow moderately in the fourth quarter.

While domestic employment growth is slowing, outsourcing plans are again on the rise. The number of outsourced employees is expected to rise by 6.5 percent during the next 12 months; in last quarter’s survey, the expected growth in outsourced employees was just 2.7 percent.