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Client Letter – October 2023

Market Results

The third quarter of 2023 was a bit of a disappointment from a market perspective.  Both stocks and bonds were down, in a quarter that felt more like 2022 than 2023.  The S&P 500 was down -3.27% for the quarter but remains up +13.07% YTD.  International markets were down -4.71% but are up +4.49% YTD.  Emerging markets were down -3.71% and down slightly at -0.38% for YTD.  The general bond market was down -3.23% for the quarter and down -1.21% YTD.  Short treasuries were up +0.71% for the quarter and are up +1.66% YTD.

Portfolio Thoughts

Portfolios were down in the third quarter due to both stocks and bonds both being down.  Given that the S&P 500 index is up +13.07% YTD, the overall market is not terrible.  But we believe the Federal Reserve (Fed) is the big issue for both stocks and bonds.  The market needs to hear that the Fed is done raising rates, and until that becomes clear, neither stocks nor bonds will have a significant rally.  The overall story of inflation and the Fed’s reaction by increasing interest rates has essentially taken over the market narrative.  Gross Domestic Product (GDP) is good, unemployment is low and general productivity is improving.  The economic picture is quite decent, but the interest rate level dominates the story.  For portfolios our Tactical model was down but just a small amount.  Good allocation choices helped.  Our Strategic model was down more than Tactical because we don’t make the same type of allocation adjustments.  The Momentum model was also down, but also only by a small amount, due mostly to the fact that its asset classes did better than most other asset classes.  The model’s Momentum signals often help with this.  Capital Preservation was also down slightly.  Overall, a disappointing, but not horrible, quarter for investors.

Q3 2023 Notes

The Fed raised rates by another 25 BPS in July to the 5.25% – 5.50% level.  It then held steady on rates at its September meeting.  But the press conference after the September meeting became a real problem for the markets.  Essentially the Fed Chair, Jerome Powell, said that it is possible, if not likely, that the Fed will raise rates again by the end of the year.  The Fed has meetings in November and December, so those would be the targets if the Fed decides to raise rates again.  The underlying story here is inflation.  Looking backward we see that the inflation measure of the Consumer Price Index (CPI) was at +4.0% in May.  It dropped down to +3.0% in June, an encouraging drop in just a month.  Then July came in at +3.2%, slightly higher, but not enough to be a big concern.  Then August came in at +3.7%.  This is a noticeably higher level and shows two months in a row of increasing inflation.  Depending on what we see for inflation in September and October, that will greatly affect if another rate increase is coming.  We expect there will be one more increase of 25 BPS to the 5.50% to 5.75% level.  Overall, we think inflation remains too high and we won’t see a big enough drop in September or October to change our thinking.  Going back to the M2 money supply we’ve talked about in the past, the money supply was up a very small amount in the third quarter, which is a good sign that raising interest rates have impacted the economy.  If M2 continues to adjust at a lower level, we feel that is a good sign.  The good news for now is that we don’t see any catalyst for the markets to go down more substantially.  We think the underlying economy is good enough that a recovery can happen if we just get past inflation and interest rate hikes.

Our global topic for this quarter is another somewhat unusual choice.  I will try to illustrate why I think this is an important topic and one with potentially significant global impact.  It starts in central Asia in an area known as the South Caucasus, so named because the area is south of the Caucasus mountains.  Specifically, the countries are Armenia and Azerbaijan.  These countries share a long border and both were formally part of the Soviet Union until its demise.  The two countries don’t particularly like each other with wars going back to the 1920’s.  Ethnically, Armenians are of Indo-European descent, whereas Azerbaijanis are mostly of Turkish background.  In the 1990’s Armenia, supported in major part by Russia, fought the Azerbaijanis over a geographic area known as Nagorno-Karabakh.  That area is technically part of Azerbaijan but is home to mostly ethnic Armenians.  By 1994 Armenia had militarily all but taken over Nagorno-Karabakh and a number of other surrounding areas from Azerbaijan.  Armenia doesn’t have a large population, about 2.8 million, and its economy is considered under-developed.  Azerbaijan was similarly under-developed, though with a larger population of about 10 million.  Starting in the 2000’s Azerbaijan found oil and started building its wealth more effectively.  Also, during that time Turkey became a stronger sponsor of Azerbaijan, mostly due to the ethnic connection.  To their benefit, Azerbaijan became a larger trading partner with Turkey, who also helped them with miliary technology.  By 2020 Azerbaijan had taken a clear economic and military lead on Armenia, though Russia’s backing of Armenia prevented Azerbaijan from taking direct action.  Then came 2022 and the Russian invasion of Ukraine.  And with Russia’s poor performance there, the Russians could not project power and protection for Armenia.  In September 2023 Azerbaijan sensed that Russia could not protect Armenia, so they decided to make a military push to settle the Nagorno-Karabakh issue once and for all.  And they did this September.  The Armenians were quickly forced to surrender, and the entire area is now fully controlled by Azerbaijan.  The ethnic Armenians are desperately fleeing the area because of a legitimate fear of ethnic cleansing, or even genocide.

So, why is this at all important?  For starters, you have a country that use to be protected by Russia, and now Russia has all but lost control of the area.  Next, Turkey is a rising country right next door to Armenia, and it now has a stronger partner in Azerbaijan, adding to its regional strength.  Next, Iran borders on Azerbaijan’s southeast and Azerbaijan and Iran aren’t best friends.  Meaning Iran may have to redirect some of its priorities to make sure that border doesn’t flare up.  Finally, and perhaps most important, Armenia no longer has a security sponsor as it had with Russia for many years.  This opens the door for Armenia to develop closer ties with the United States, who can offer some degree of security.  This puts a big dent in an area that used to be completely dominated by Russia.  And will ultimately lead to Russia losing more of its own regional strength in the region.  Collectively, we feel these changes could very easily result in big changes in the Central Asia region, and could also have global implications.

As always, we will watch and research the global economy and make investment choices to the best of our ability for each and every client portfolio.  If you have questions about your portfolio, our views expressed in this letter, or anything else financial, please do not hesitate to call.

Best Regards,

Jim

Barron Financial Group, LLP is a fee-only Registered Investment Advisor regulated by the Securities and Exchange Commission.

This newsletter is for general information only and should not be considered investment advice.  Investors should consult with a trained investment professional to discuss their particular situation.

Barron Financial Group, LLP is a fee-only Registered Investment Advisor regulated by the Securities and Exchange Commission.

This newsletter is for general information only and should not be considered investment advice.  Investors should consult with a trained investment professional to discuss their particular situation.

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