2024 Q1 - Ken Entenmann

Welcome to Quarterly Market Insights, a special series part of CenterState CEO's podcast Talk CNY, presented by NBT Bank. This quarterly series will provide a data-driven economic analysis, and how it could impact you and your business. 

Welcome to Quarterly Market Insights, a special series of Talk CNY, presented by NBT Bank. On our quarterly episodes, we speak with Ken Entenmann, Chief Investment Officer and Chief Economist of NBT Bank. In our episodes, we talk about the data that we're seeing about where we've come from and indicators that tell us where we might be going. In this episode, we will talk about the three basic elements that make an economy move forward. Ken will give us indicators as to what we're seeing in each of those elements and what it might mean for us individually and as a region as we move forward into 2024. Ken, welcome. Thanks so much for being here. Excited to kick off 2024 with our first market insights and looking forward to our conversation today. Great 

to be here. Looking forward to our second year. 

Absolutely. So, 2023, was an interesting year for us. It kept feeling like we were just kind of waiting for something to happen and then waiting for something to happen and then waiting for something to happen, but a lot of great information for us to go through and share. And I know you and I are getting ready for this session. We wanted to kind of bring it back to some of the rudimentary basics of economics and maybe present what we're seeing currently through that lens. And so being the economist, I won't dane to talk about it, but I know when we really look at what's happening in the economy, there's kind of three basic inputs. Walk us through what those are. 

Yeah, so I'm sure most people don't want to go back to their macroeconomics class, but the economy is really broken down into, if you think back to macroeconomics, C plus I plus G. That stands for consumption. It stands for investment, and it stands for government. There's also an import, export number, which is typically a minus two or 3%, but it's really the consumer, it's business, and it is government. 

And throughout 2023, we were imminently waiting for the recession to happen. Really, for two years we've been waiting for this imminent recession and it just hasn't happened. I think going back to that C plus I plus G, I think it helps explain, why don't we break that down? The C part consumption, which is by far and away the biggest part of economic activity is about 68% of the total economy. And the consumer has been going crazy and there's good reason for it. And part of the recession scenario is if we had a recession or if the consumer pulled back, it would cause a recession cause and effect. We can debate that later, but the reality is the consumers may remain incredibly strong and many people, so I like to joke, they've been acting like superheroes carrying the economy, but many economists are afraid they're more like Thelma and Louise and we're going to drive off a cliff and the recession's going to happen. 

The reality is the consumer remains really strong. And I think the reason for that is when you look at your average American's balance sheet on the asset side, their two biggest assets are their home and their retirement savings. So last year the S&P 500 was up 26% in the MBT footprint, which is basically the seven northeastern states, the average home price is up 49%. So if your home price is up 49% and your investment accounts are up 15%, that creates a wealth effect and the propensity to spend goes up. And then when you look at the liability side of the average consumer, by far and away, their biggest liability is their mortgage. And because of covid, everyone had an opportunity to take advantage of refinancing or establishing a mortgage with 2% or 3% whole numbers in front of it, which is really unprecedented. 

And so when you take the balance really strong balance sheets of assets going up a lot and the liabilities being managed down, I don't think that's going to change. And I think one of the kind of mysterious things about economic forecasting is that interest rates went down so low and both businesses and consumers refinanced and locked in very, very low rates. So I believe that as we debate the Fed, one of the reasons why the Fed rate hikes haven't had as much impact as theoretically they should have is because people aren't sensitive to it because locked in those low rates. 

We're certainly seeing it from the standpoint of new homeowners and those kind of things in the housing market itself. But from that consumer spending standpoint, by and large people have those mortgages locked in, especially when you consider where the bulk of expendable income comes from in the geography or in the demographic section. It's really those that have already purchased that home and already have that 

Equity. Absolutely. And so when we look at kind of prospectively, is that consumer going to remain strong, there is some deterioration on the lower income scales, credit card balances are going up, delinquencies are going up, but nowhere near any alarming rate. In fact, they're still historically just kind of getting back to average. Something to watch, but hardly alarming. And the second thing, and we had some employment statistics this morning, the employment market remains really strong. I think particularly for the members of CenterState CEO, which are predominantly small businesses, everywhere I go, whether it's nurses and doctors' offices or hospital facilities, advertisements for New York state troopers, city of Rochester police officers, the back of every truck I pass on the throughway and I spent lot of time on the throughway, help wanted signs for CDL drivers and NBT's core commercial customers are small business. And almost all of them are either just getting to kind of a normal labor environment or they're still struggling. So what does that mean? It means employment's going to probably remain fairly strong, and therefore the consumer is likely to remain short and the C part of it will be pretty solid. 

Got it. So I think the other thing that's really interesting about that, before we get into the investment in the government spending. We had some new CPI numbers out a week or two ago and year over year down, but up. What did that number mean to you when you saw that coming out? And is that still an indication? We talked a lot last year about inflation being sticky, right? And is that still what you're feeling? Like is the case given that number or does that shift your thinking? 

No, absolutely. Inflation is proving to be sticky. That something. That was a leading question. Yes, thank you. I appreciate the easy question. But we had CPI or consumer prices on Tuesday. They were stickier than expected and higher than expected. And we had producer prices or PPI this morning and on Thursday morning, and they both proved to be stickier. The good news is the trend is still moving in the right direction, but economists think in terms, and politicians by the way, think in terms of rate of change. So the fact that inflation is stuck at 3% doesn't mean it's coming down. The trend is coming down, but it's the rate of growth that's coming down. So prices are still going up 3%, they're going up, they're not going down. Correct. Now that three point, that 3% rate of change from 3.2 may be moving in the right direction, but it's still inflationary and it's still growing, and that's where the stickiness comes in. 

And it's had a really dramatic impact on the marketplace's expectations. Much of the enormous rally we saw in bonds and stocks in the third and fourth quarter were based on the notion the Fed was imminently ready to start cutting interest rates and would aggressively cut rates. So if we, and December wasn't that long ago, just two months ago, the expectation was for the Fed to start cutting rates in March. They'll meet next Tuesday and Wednesday. So the first rate was supposed to be in March, and there were maybe five or six projected for the year after this week's inflation number we're stretched out to June, maybe July for the first rate cut. And we're kind of teetering between two or three. That's a big difference between a March rate cut and five or six rate cuts versus now we're wondering if we're going to get it in the first half and whether we'll get more than two. 

So gigantic change in interest rate forecast. What I do find somewhat head scratching is the S&P 500 and the equity markets remain on a tear. And I think when I look at stocks, I think of it in terms of the numerator and a denominator where corporate earnings or business earnings are in the numerator, and quite frankly, they've been pretty solid. But in the denominator is interest rates, whatever discount rate you want to use for your individual business. So I think what's happened is the earnings, the numerator has grown and has kind of compensated for the disappointment that rates haven't come down. So you still have rates. The good news is they're not going up. Everybody's kind of concluded that they're not coming down as fast as people hoped. But I think the numerator has grown fast enough to, it turns the market on a positive note, but the S&P 500 is up roughly seven and a half percent year to date. So we've kind of brushed aside the stickiness of inflation and rates have remained a little bit higher than certainly what the market was projecting in the fourth quarter. I'm not sure that's sustainable. I worry about it. But for the time being, the stock market and the economy continue to grow at fairly robust levels. 

So it's a great transition, I think, to start thinking about that "I". Right, the business and the investments. And you talked about numerator being the earnings and the denominator being the cost of capital, correct. Working cost of capital. And so that becomes a huge part of a company's decision making process when they look at investments. And while consumption has been really strong and they've been, the superhero investments haven't really been the sidekick that we would like them to be to the superhero over the last couple of years. Correct. Isn't that right? 

Yeah. And so when we look at the "I" and the "G," they're roughly 18% give or take of economic activity. The "G" has grown a lot. We can talk about more of that later. But the "I" part has been a bit of an enigma when you think of the stock market and how strong it's recovered in the last 18 months, business investment has largely been flat. And I think part of that is businesses were severely impacted by COVID. Not that individuals weren't, but I think the individuals were, it was a little bit easier for them to turn the switch on, whereas businesses struggle through those supply constraints, they struggle through the difficulties in the labor market. And it's been two years, give or take since the major impact of COVID. I don't know if it's long enough for businesses to kind of shed the scars that they experienced in that economic shutdown and combine that with the forecast of an imminent recession that we lived under for two years. 

The "I" part of it, business investment has not grown much. I do think that's an opportunity if we can get additional confidence, and ideally it would be that economic growth doesn't continues to grow, so no recession and then it accelerates to the point where the interest rate decline isn't what we're banking on to make our economy go. And I think that's kind of where we're feeling it out right now. And my hope is that businesses will kind of get over that COVID hangover, realize that the labor markets are starting to loosen a little bit and kind of go back to normal and invest a little bit more. But that has been the weakest part of our C plus I plus G story. 

To theorize a little bit too. I think you have a couple of factors in all of that. First of all, I think we're seeing a different trend line here in the region, largely driven by some of the stuff we've talked about in the past. Obviously, the Micron announcement, the strong economic development pipeline we have because of some of those supply chain issues and companies looking to near shore/ re-shore. So I think we're seeing that differently. But what happens here is not necessarily going to be a reflection on the national economy, but I also think that at some point you get to a place where you kind of have that built up demand where you say no to those projects and you can only say no so many times. And there's been periods of times in our country where we've had interest rates that are 50% to a 100% higher than they are now, and companies have invested. So I think it's getting over that what used to be a zero-base environment. And I think the workforce, as you mentioned, is a huge part of that. It's one thing to make an investment on a new line and bring in the equipment, but if you don't have the people to operate it, it makes that an even harder calculation to make. 

Yeah, absolutely. We tend to have very short-term, time horizons when we do podcasts and economic forecast. Everything's going, where's the S&P going to be next week or next quarter? And really, businesses should be thinking in terms of years. And when you look at history, whether it's World War II or the Vietnam War, the social unrest of the sixties, the inflation of the seventies, I kind of chuckle a little bit when people are like, boy, it's so bad right now. As if everything was copacetic in the last 50 years. And so there's all kinds of landmines that the economy is forced to struggle through, and that's the history of our economy. And so you're always going to have pockets of weakness, pockets of uncertainty. I think 2024, that uncertainty is going to be heightened because of the presidential election cycle. And I do think the government spending, so if you look at Central New York, the Micron deal is a big deal, but I don't think it would happen. 

if there wasn't the CHIP program. Absolutely. And so that gets us to the G, which has been growing remarkably in the last week or so. The White House put out their budget, which is over $7 trillion in spending. Now, they will say they reduced the deficit because they were going to spend nine, but they're only spending seven. But two years ago, the budget was for $4.6 and then it was $5.2, and now we're $7.3. So that spending is occurring and a good chunk of that CHIPS act infrastructure, all that money, all that stimulus is still to come. So you allocated, so for example, the Infrastructure Act allocated $7 billion for electric EV charging stations. The government has put up zero. 

Correct. 

I don't know what they're waiting for. And that's an argument against government efficiency. But nonetheless. That's still a whole other podcast. Well, that's true, but there's $7 billion to be spent in that very specific neighborhood. So I do think the government spending, there's a stimulative impact to that, and hopefully that might encourage the "I" to more private investment. But I also think the debt numbers, the deficit numbers are beginning to become alarming. And I've seen politicians from every stripe, every left, right center, middle, everybody says the spending and the deficits are unsustainable. Nobody wants to do anything about it. And just by the sheer percentages, social security and Medicare, and particularly Medicare, because we have such a big bulge of older people going through the population, it is very difficult to see how you're going to corral spending in the Medicaid, Medicare world. So, that I think while "G", so if I look at the "C" plus "I" plus "G," the "C" and the "G" have been robust. The "I" has been very cautious. And historically, unless you get the "I" to participate businesses to be really aggressively growing, it's hard to sustain that. Well, 

and we don't have to get too deep into it, but it goes back to your, there's an import export piece of that. And if the investment isn't there to create the GDP and the consumption is there, it's not coming from here. And so you create trade deficits and it becomes problematic. And you're absolutely right. The government spending, while positive in many ways from the stimulative effect, you borrow money, you got to pay it back. That's just kind of the basics of it. We know that in our household spending, and there's probably some really difficult decisions and conversations that need to be had in the not too distant future. You can only kick the can so far. 

And the ability to kick the can has relatively easy the last 10 years because we had 0% interest rates, correct. Now we have five and a quarter or four and a half, depending on what part of the yield curve you're looking at. But four plus interest rates when there's zero, you can grow debt. And it's relatively painless when they're 5%. So when you look at the deficit just year over year, it was about a trillion dollars two years ago, last year it grew to about 1.7, and it's appearing to be about $2 trillion this year. And more than 50% of it is due to rising interest rates, the cost of financing that debt. So the ability of the government to borrow to stimulate at some point that you pass a point of no return and it becomes a big negative. I don't think we're there yet, but I also think that's one of the reasons why the "I" is so cautious, because they're looking at that saying, let's not make any, this is a difficult problem to solve, especially when you put it into a relatively divisive government. It's hard to be optimistic on it. 

Yeah, and I think we, we've said this point before, but for folks that have a hard time thinking about billion, trillion, what the difference is and what that looks like, I mean, just think about our own buying capacity, going back to the housing issue, right? Absolutely. What you can get, what you have to pay monthly for a $200,000 home at a 3% mortgage, which is essentially where we were with the 0% rates, Fed rates, going to that 3% market rate, and where you are now just 4% higher or even 3% higher, it's not a 3% shift in what that payment is because people have to remember interest is compounding. And so as you start adding those, it becomes really problematic, which is why, like you said, that increase in the debt load was due to that interest increase. So I think that also is inherently part of the challenge of when do you lower rates and when do you nod and what does that look like? But we've certainly had harder choices and made bigger problems for ourself when looking at that historical lens. But it's certainly something that I think is going to be a topic. Certainly not this year in an election year. Nobody's going to do anything about those challenges in an election year, but we're going to be forced, I think, to deal with it before the end of the 2020s 

And to a point that you made earlier, life goes on, whether you're an individual or a business. If your business is booming, and you need to put another wing on the factory, you can wait a little bit hoping that you're going to get lower financing costs, but you can't wait forever. Similarly, on an individual, if you're waiting to buy a house because your family's starting to grow, you can kind of wait it out a little bit and take the inconvenience of being squashed in a small apartment, but sooner or later you've got to buy a house. And that price sensitivity disappears over time. And I suspect, and I would call, I don't have any grand delusions at my interest rate forecast are better than anybody else's, and most people's are pretty bad. But I think the likelihood that mortgage rates go back to 2% or commercial loans start again being issued with 3% handles. 

I think those times are largely behind us. And I call it sticker shock. Well, the last time I borrowed money, I got it at three and a half. Well, this time it's going to cost you six or seven. And there's a sticker shock that says, well, I'm going to wait to go back to three between the sticky inflation, the government finance numbers, I'm not convinced, that's not to say they can't go lower. I'm not arguing whether the 10-year, so this morning, the 10 year treasury went from 420 to 430 rough numbers, based on the inflation report. I'm not arguing whether four or four and a half, that's almost immaterial to somebody's long-term decision. But if you're waiting for it to go back to two, I don't think it's going to happen. And I think businesses need to get acclimated to the fact that the cost of capital's gone up. 

So it'll be interesting to monitor over the course of this year what happens in that "I." I think we're obviously going to have a lot of great exciting things to talk about here in Central New York. I happen to know that we were meeting with some of our leaders today and talking about our economic development pipeline, which is like $8.8 billion right now, which is crazy to even think about. We won't land all of that here, but even if we're landing 20 to 30% of that, that's a lot of investment in Central New York. But those are not numbers necessarily that are moving the national averages. And so I think it'll be great for us to monitor that over the course of the year. And I think the other thing, to bring it home a little bit, I think too is the dual challenge for the individual is not just those rates, but it is that inflation. And so I think that probably to go back to our earlier conversation, businesses are looking at that and going, okay, is the consumer really that superhero? Or as you said, the great reference to the wonderful movie, Thelma and Louise, not a great ending, but they're going back and saying, is that what we're seeing in this? And so it'll be really, really great to monitor this over the course of the year. Yeah. 

I think that the consumer right now is not going to drive off the cliff. The question is in December or March of next year, do those numbers deteriorate? And that remains to be seen, but they're starting from a historically really sound place. Yeah. Balance sheets out. And that's why I think the likelihood of an imminent recession is really low. Of course, some macro event can happen. 

We saw that in 2020, didn't we? Right, 

exactly. And so of course can happen, whether it's the Lehman Brothers collapse in '08 or COVID in the early twenties, by definition, those are unpredictable. So you allow for that outlying event, but barring that, the consumer's going to be fairly healthy. And it doesn't mean the economy can't slow. And most forecasters saying it's going to slow from the three percentage area down to more of a two percentage area, and the numbers are kind of indicating that it is slowing but not heading into recession. So I think we're in pretty good shape, at least for the first half of 2024 and beyond. And I think a good thing that's happening is you have the market was up robustly in the fourth quarter. You were getting great earnings and strong economy and the expectation of much lower rates. Now you're getting a good economy with good earnings, but the rate thing is stable, which is not going up. That's a good thing. It's not thing going up. Exactly. So it's better than going up, but it's not going down as fast as people anticipated. And I think there's going to be kind of a give and take in the economic environment where people feel that out. But as we just said, sooner or later, if you're a businessman, light goes on. You got to move. Yeah. So we have the more wonky individuals in this office here are actually contemplating whether or not we want to put a betting pool in place to see when that first rate cut comes. I noted June, July was your recommendation. We can talk offline if you want to get in on it, and that's consistent with some of the other folks in the office. I tend to be an optimist, and so I'm dialing that back a little bit more, but I think it's probably three. Everyone else thinks it's probably two, but it's probably, it's not the five that we were looking at before. In 

Terms of number of cuts, I would argue that the five is highly unlikely. The probabilities for a rate cut in May drop to about 10% today. So some people are holding out. That puts us to June and July. That puts us to June and July. And once you get past July, you are in the heart of the political season. And not that the Fed can't change rates one way or the other, but historically they've been loathed to do it. They don't want to be perceived as putting their thumb on the scales one way or the other. If they don't cut rates, people can complain they're hurting the existing administration if they're cutting. So you're going to get beat up no matter what you do. So they typically, unless they are absolutely forced to, kind of call a timeout, and so if you're looking for three rate cuts, let's presume June is the right answer. Well, then you have June, maybe July, then you have a timeout for the elections, which leaves you December. So June, July, December would be three. If they don't go in June, it's tough to see. Much of the talk in the marketplace today is now pushing rate cuts out into 25. Yeah. 

Yep. Absolutely. Well, at least they're not going up. As we said, 

We got that going for us. 

And I really, as always, Ken, really appreciate the conversation and the expertise and intelligence and insight that you bring to this conversation, and I learn a ton whenever we talk. And so I'm looking forward to once again, having these conversations with you quarterly. 

Well, it's great to be here. I learn a ton when I come too. And for Central New York, the Micron situation truly has a game-changing potential, and I'm sure everybody here at CenterState and really everybody is eagerly awaiting an announcement from the CHIPS Act. Absolutely. Hopefully that will come sooner than later, but it's 

fairly confident the next time you and I chat, we'll be talking about the allocation. 

I hope. I hope so. Let's hope we'll keep our fingers crossed. Sounds 

great. Well, thank you, Ken. 

Thanks for having me. 

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