2024 Q4 - 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. Ken, thanks so much for being here. Great to be here. Excited to chat with you, wrapping up the year with our fourth quarter Quarterly Market Insights and really excited to chat with you. Lot's been going on even though it hasn't been dramatic changes, but certainly it seems like maybe there will be some to come. Welcome. Thanks. Great to be here. Yep. I know we wanted to get started talking a little bit about the state of the economy, talking about some of those standard metrics and just kind of what we're seeing. Why don't we jump into there?

Sure. Well, the economy, if I were to put one word on the economy for 2024, it'd be resilience. It's been remarkably resilient. GDP growth in the third quarter was 2.6%. Pretty solid economic growth, especially when you think to the beginning of the year when everybody was still forecasting a recession. It's pretty clear we haven't had one. The fourth quarter is running estimates between two and a half and three. These are pretty good economic growth numbers. What is driving that - unemployment, while it has softened a little bit, still remains remarkably strong. The rate itself has gone up from 3.5 to 4.1, but that's really a bigger function of more people entering the workforce, which I think in the long run...

Is a sign of strength, not a sign of weakness, but again, at beginning of the year, everybody thought unemployment would be in a recession. When you do have a recession, typically unemployment spikes, but we haven't had one and unemployment remains remarkably strong. If you told me the beginning year we were going to get 2.6 GDP and a 4.1% unemployment rate, I'd be really psyched about that. The last thing that has been a really big factor was a huge factor in the election has been inflation.

And the good news is it continues to kind of grudgingly improve. So if I use the consumer price index, that number has gone from nine two to the mid-threes, so substantial improvement. The problem is the numbers have been kind of stubbornly, kind of flatlining over the last half of the year, but even then if you told me I was going to get an inflation rate between 2.5 and 3% given that we were at nine, that would be pretty good. The macroeconomic situation is pretty solid.

In the last episode, we talked a lot about the stickiness of that inflation, really a lot of that being tied to shelter costs, not all obviously, but that number was such a big portion, a percentage of that, and we know that the cost of housing because supply is down, demand is high and that's driving it up.

And I mean my gut tells me we're going to be talking about housing for a long time, both nationally, but specifically here, we'll talk a little bit about the chips act later, but assuming that that moves forward, the demand for housing in the Syracuse market is going to be pretty robust. And it was a contentious issue in the election because home prices are up and mortgage prices are up. What economists call the affordability index is pretty high and remains high, and, unfortunately ,there's only one way to fix it really is to grow out of it, and that's going to take some time.

Yeah, I mean it's going through the process of building and growing so that you are achieving that balance more equally there and lowering those inflation rates. That's great. So election, we've talked about that a couple of times, definitely want to talk about the potential impacts and leading up to this, you were sharing with me that when it comes to the office of the president, there's really kind of four things from the government that drive impacts on the economy. Sure. Tell us all about those.

It is kind like the Wizard of Oz, lions, tigers, and bears, right? I would summarize, obviously there's a lot more to it, but I would summarize the major impact coming out of the election as tariffs, taxes and regulation. And we've had a pretty healthy rally in the equity markets since the election, very healthy rally. And I think the things that are driving that are taxes. So probably the one area where there was a big difference between the Democrat and Republican candidates was taxes. We have the 2017 Tax Act that lowered individual taxes and brought the corporate tax rate down to 21. That expires in 2025. Vice President Harris was proposing letting that expire. Individual tax rates in general are going to go up and specifically the corporate tax she was proposing going from 21 to 28.

Where president-elect Trump was saying, we're going to renew that tax act and we're going to keep the tax rate a corporate tax rate at 21 and maybe even provide some incentives to make it lower. I'm not advocating one or the other. It was so much uncertainty. If you're running a business and you have no idea what your tax consequences are going to be for any kind of major project, it just creates uncertainty and puts you on pause. You can't run net present values. You can't figure out cost of money.

It's all that thing. And there's legitimate concerns about tax revenues because we are running significant deficits. We talked about that. There's a lot of debate about that. But whether we like it or not, I think the tax part of it has become clear, pretty clear. Secondly, the combination of a more certain tax environment with the hopes for a lighter hand when it comes to regulation, I think revived the animal spirits of the markets a little bit and energized them. And I think that largely explains why the markets have gone up so strongly post-election. However, there's this idea of tariffs that it is potentially very worrisome. First, if you go to any economic textbook, they're going to tell you tariffs are bad.

Bad, yeah,

Absolutely.

With no context,

They'll tell you that. But I think they truncated the sentence. The full sentence should be, tariffs are bad in a full and fair market. I challenge most people to tell me where the full and fair market is free and fair market. And so the mystery or the question that remains is in a perfect world, tariffs are bad. Are they going to come to their full fruition where it's 60% tariffs on all goods from China and 10% on everybody else? Or is President Trump using them as a cudgel to kind of set the negotiation stage so that we can do it? And I don't know that anybody can answer that question. What I will say though is you've seen a number of the foreign officials coming to meet with the Trump transition team. Last week, Trudeau from Canada was down in Florida talking about the potential for tariffs and how they can negotiate.

And it ties in fentanyl and drugs coming over the border. It ties in immigration. So it's a much bigger picture. I would agree that tariffs are bad. They tend to be inflationary and get passed along to the consumer. And that's the general reason why people don't like them. But I think it remains to be seen the extent to which they actually come to fruition. And if they are used as a cudgel, what do we get as part of that negotiation? And my gut instinct is you're not going to get the full impact of them. And if you can get a better trading environment on the global economic stage, it might be beneficial. But on face value, tariffs are bad. And there's this tug of war between tariffs being potentially bad, but certain tax policy and hopes for less deregulation. When you put it all together, there's a little bit of a tug of war there, but right now the market's focusing on taxes and regulation and has taken a positive tilt with this kind of eye looking over their shoulder at what will the tariff discussion really look like. The other thing I would say, Andrew, is all of these things, the taxes are a little bit more certain, but any changes to the regular regulatory environment are going to take months if not years.

And then the impact.

The renegotiation of the tax policy is going to take several months to get through Congress, and the tariffs just don't happen overnight. So I think again, that the positive impact on the markets is just this reduction of uncertainty and a little bit of a revival of animal spirits.

And in some instances you probably would've seen that reaction regardless of the outcome because you create certainty which allows you to make decisions. Right.

My gut is that the markets are looking at the tariffs and really thinking they're going to be used as that negotiating tool. And the worst case scenarios not going to materialize. We don't know that. But the other thing I would add when it comes to elections, so we spend all our time talking about the president and rightfully so, because clearly a super important position, but the constitution of Congress really plays into that. I think this week we got certainty that the house is going to remain in Republican hands and the Senate we already know is converted. So you're going to have a full control Senate house and White House all under Republican control. And that I think enables businesses to take a little bit more certainty, especially with the tax and regulation.

Exactly. And you're right, even if it went the other way, I think the conclusion would've been that the tax policy might be renewed, but not to the full extent and that the corporate, but as a CFO of a corporation, I just want to know what it is. If the tax rate is 21, I'll plan ahead. If it's 28, I'll plan accordingly as well. But I can't live in no man's land. And the fact that the control is all under Republican, it's all in Republican hands, gives a little bit more predictability to always uncertain policy.

Making your choices, making your decisions allows you to have more of a clear picture of that. Exactly. Something that obviously as a result of the elections and really was a big part of the story here, when Speaker Johnson came and was here supporting then still Congressman Williams, but who lost his seat when Speaker Johnson was talking about, I don't think he had any intent with this. I think he probably didn't even realize what he was saying at the time, but when someone raised the Chips & Science Act and he said, oh, I think we're going to repeal it. And of course that set the community in a bit of a state of panic because we've talked about it before. There's three things that is making the Micron project happen here. It's the land and the opportunity, it's the state incentive, and it's the federal incentive. And the federal incentive, if it goes away that's not happening anywhere in the country. I think we've had a lot of conversation with other electeds. We've had a lot of conversation with Micron's leadership, and I think the reality of it is, is that from our perspective, and I'd love to hear your perspective, but that's likely one of the things from the Biden Administration, while it may end up rebranded or under a different name, won't get repealed for two reasons. One, you have projects all over the country that are in both red and blue states. And two, it was a very bipartisan bill. You had a lot of support on both sides of the aisle for that. And today we look at that and I think it's very unlikely that that has any kind of meaningful impact on Micron's ability to move forward here.

Yeah, I think that's basically right. And more important than the political battles, it's pretty clear from a national defense and from just a general economic health that having a microchip capacity domiciled here in the United States is an ongoing thing. It's not a flash in the pan. We're going to do this for three years. It's clear this is going to be an economic necessity going forward. In addition to that, President Trump's made a big deal about bringing manufacturing jobs back to the United States. It's a big part of the tariff discussion that if we can put tariffs on foreign countries that are on not playing fairly, that would prove to be an incentive for companies to establish manufacturing plants here in the United States. So it wouldn't surprise me if there were adjustments, rebranding, maybe a refinement in terms of where certain monies go. But I think the spirit behind the CHIPS act, particularly at the National Defense and just it's such a key component to economic vibrancy. It may be tinkered with, but my sense, particularly specifically here in Central New York, the plans there are so far down the road that I hope, fingers crossed, yes, sure, sure. But I would hope that facility, certainly the first two stages of it, the first two fab plants, I'd be shocked if that didn't come to fruition.

Well, you've, in our conversations over the years, taught me that nothing is certain. So I won't say with a certainty. That's where the hope comes in. But what I will say is barring global pandemics or bankruptcies, this project isn't going anywhere else. This project has to happen here for them to meet that timeline. There's a lot of speculation out there. We've heard it before. Oh, well, they announced the delay to November and then this happened. And so there's like, oh, something's behind the scenes conspiracy theory stuff. But the reality of it is, is that they're on the timeline. They thought they would end up being on, may not be the one they wanted to be on, but this environmental impact statement that they're drafting takes a tremendous amount of time and energy and effort. They've invested hundreds of millions of dollars in this project already, and they've got a market that they have to be ready for. They got to be producing chips in 27, 28.

And I think if you take that regulatory conversation we had earlier streamlining things and making it happen, I would argue that a Trump administration would be more sympathetic to advancing these things so that they happen faster, not slower. And that includes environmental reviews. We're getting towards the end of the year here, resilient year. We've got all of these things a little more certainty. I know you don't like making predictions, but what are your expectations? What are your thoughts as we go into 2025?

Yeah, my commentary to our clients and people like you is to manage your expectations. As of today, the market S&P 500 is up roughly 25%, and that's after a pretty strong year in 23 as well. So we've had remarkable returns in the equity markets, and what drove that this year was one, we didn't have the recession, so that was really good. And that pushed corporate earnings to be much better than expected. That's really good, but that's hard to repeat. And I would also argue that the market reflects that pretty much.

The most basic way we measure this is with the price earnings ratio. So if I look at the price earnings ratio of the S&P 500 today, it's roughly 23 times earnings, which historically is really high. And people are arguing that particularly the innovation of technology, specifically AI, artificial intelligence, is going to help drive corporate earnings and increase productivity. I hope they're right. But we've had a history full of new innovation that comes in and everybody gets really excited and stocks get priced very richly. I don't think there's any doubt that prices are pretty fully valued right now. The other thing I would say when it comes to the markets is the expectation for a slowing economy. A recessionary economy led many people to predict that interest rates would be materially lower than they are now. When I go back to the beginning of 24, the expectation was for four or five rate cuts, six rate cuts in some cases, and so far we have two probably get another one next week. I think that's about a 75% probability if you look at the futures markets. But you're getting three, not six, that's half of what you expected. And more importantly, the economy as we talked earlier, is more resilient. So there's this debate and the tug of war in the marketplace as to how low can interest rates go. And generally speaking, the expectation is while rates will go lower, they're not going to go as low as we were anticipating earlier in the year. Which again brings into question the richness of the valuations of the equity markets. So I think there is scant evidence of any kind of major economic slowdown recession that's imminent. So that's great news. I think AI has the potential to increase productivity, which would enhance earnings. And interest rates, while they may not go back into the twos or threes are at least declining and still on a historic basis, remain pretty low.

So you put that all together, that's a pretty favorable backstory. You've got pretty solid economic growth, 2.6 GDP, even if it's slows to two, that's the long-term trend. You have a catalyst for corporate earnings and AI and perhaps increased productivity. That's pretty good. Is it reflected in the PE? My guess is yes. Interest rates are pretty modest, so I put that all together. That does not lend to a forecast of doom. It's a pretty good, cautiously optimistic scenario, but the world is always filled with uncertainty. Oh, it's filled with uncertainty.

We still have a lot of geopolitical risk in Ukraine and Russia, and with the Middle East. The tariff negotiations can create a whole lot of tension. The road may look pretty clear today, and you can cite all the positive reasons why we should be okay. It's what we'd normally refer to as a black swan. It's that unexpected event that can knock things off track. And when you're trading at 23 times earnings, that when you have that, it could

create challenges...

...prove to be painful. Yeah, absolutely.

We've all seen the bubbles pop before.

My gut instinct is, we'll, grudgingly go higher, but I would manage your expectations. I think the likelihood that we have yet another 20 something plus return next year, I don't know if I would be hitting the ranch on that. I'm not betting on that.

Yeah.

Well, I always appreciate the conversations and bringing the economic development optimism view with the pragmatic economic economics view and seeing where we align on all of those things, which is good. And I'm looking forward to another year of having these conversations, and we'll see you in Q1 and see how you do so far in 25. It's been nothing but fun. I love doing these things. They're always intellectually stimulating. I thank CenterState for inviting me and want to wish everybody out there happy holidays. Absolutely.

Thank you. Thank you. Good to see you. You too.

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