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CFOs: capital spending, employment growth to slow

Chief financial officers say that employment and capital spending will slow over the next year. The CFOs point to inflationary pressures on input costs, such as high fuel and health care costs, as well as increased costs of short-term borrowing. They also say they lack the pricing power to make price increases stick for their own products.

These are some of the findings of the June 2005 Duke University/CFO MagazineBusiness Outlook survey that asked chief financial officers from a broad range of public and private companies globally about their economic projections. The survey was concluded May 30 and generated responses from 602 CFOs, including 365 from the U.S., 153 from Asia, and 84 from Europe. Results in this release are for U.S. firms.

This quarter, 40 percent of U.S. CFOs 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. Forty-six percent of CFOs were more optimistic last quarter, 54 percent were more optimistic two quarters ago and more than 70 percent were more optimistic a year ago.

To understand the causes of this reduced optimism, the survey asked executives to choose the top three items, from a list of 15, that are concerns for their companies. For the second quarter in a row, health care costs top the list of concerns. In the U.S., nearly 40 percent of CFOs cite high health care costs as a top issue. CFOs expect health care costs to increase by almost 9 percent in the coming year. High fuel prices, increased interest rates, and reduced pricing power round out the top four concerns for U.S. CFOs.

Not only do U.S. CFOs list rising interest rates as one of their top current concerns, they say additional interest rate increases will slow U.S. economic growth. "The Fed has raised interest rates eight times with no impact on the economy. The CFOs are telling us 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.

In part due to higher interest rates, corporate executives are reducing capital spending plans. While two-thirds say they will increase capital spending in the next 12 months, the increase will average only 4.5 percent (down from 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, down slightly from an expectation of 10.4 percent expressed last quarter."

Price increases at U.S. firms are expected to average 2.1 percent next year, up slightly from the 1.95 percent price increase anticipated last quarter. In part, this low level of price inflation reflects the inability of U.S. firms to make price increases stick due to a highly competitive economy. At the same time, input costs are increasing, putting the squeeze on corporate profits. In addition to rising health care costs, 53 percent of U.S. CFOs say rising energy and raw materials costs are the main reason that companies feel the need to increase prices, while 18 percent say labor costs are leading to higher input costs.

Domestic employment is expected to increase by 1.4 percent this year, down from plans expressed last quarter to increase employment by 1.7 percent. Forty-three percent of companies say they will increase employment by a small amount in the third quarter of 2005, 16 percent by a moderate amount and only 2 percent by a large amount. Employment growth will slow moderately in the fourth quarter of 2005.

While domestic employment growth is slowing, outsourcing plans again are increasing. The number of outsourced employees is expected to rise by 6.5 percent during the next 12 months, up from expected growth of 2.7 percent in last quarter's survey.