It’s unlikely the Federal Reserve chairman is ever going to win a popularity contest, no matter what actions the Fed takes. Consistent with past chairmen, Jerome Powell has faced tremendous scrutiny by market participants since his appointment. In the past several months, outspoken critics have claimed that Powell waited too long to tighten policy, which facilitated high inflation; that he is pushing interest rates too high and unnecessarily roiling the security markets; and, that he is following the pattern of past chairs and tightening too much, which is going to push us into a severe recession.
Like many pundits, the EIA team has a variety of opinions regarding the performance of the Federal Reserve and the actions the Fed should take; however, we do not express them publicly nor are they relevant to the IFED investment strategy. The IFED strategy relies on a proven, rules-based approach that uses 30+ years of research on the association of Fed policy with security returns. Thus, we stick to the script and avoid the knee-jerk reactions that plague most investors. We don’t let our emotions or opinions creep into the IFED strategy.
The IFED Strategy: An Active, Rules-Based Index Approach
The IFED strategy relies heavily on policy signals gleaned from Federal Reserve actions. The strategy is an active, rules-based index strategy, which unlike the typical index approach is dynamic in nature, rather than being static. The IFED strategy captures the advantages of rebalancing to maintain alignment with changing market conditions, while avoiding unnecessary frequent turnover in the portfolio. Most index strategies apply static rules that maintain exposures that are only optimal for certain market environments, and most active strategies trade too frequently based on emotional responses.
IFED Performance Since Going Live
Since EIA’s first customized index (Nasdaq IFED-L) was launched on June 9, 2020, the IFED strategy has identified six shifts in the market environment. With each shift, stocks that were positioned to prosper under the old environment were replaced with stocks positioned to prosper under the new environment.
How has the IFED approach performed since going live? As the saying goes, “the proof is in the pudding.”
The graph shows that Nasdaq IFED-L has been far and away the best performing of the most prominent market and factor-based indexes, including those tracking growth and value stocks, which oscillate between outperformance and underperformance. Nasdaq IFED-L’s superior performance has been achieved during a period of very diverse monetary policy and economic developments, which supports the strategy’s efficacy across assorted market conditions and Fed policy initiatives.
The consistency of Nasdaq IFED-L’s performance throughout the period highlights the IFED approach, which selects quality stocks that are positioned to prosper in the prevailing market environment. By relying on quality metrics to select stocks, the strategy avoids the severe underperformance experienced by speculative investment approaches that falter when markets are influenced by unexpected return drivers. The typical factor-based strategy goes through boom-and-bust cycles as the factor exposures rotate through in-favor and out-of-favor phases. Note for example, the performance of the S&P 500 High Beta index, which in chronological order goes from substantially inferior performance to robust outperformance and then returns to a period of substandard performance.
IFED Strategy Long-term Performance
While the live performance of Nasdaq IFED-L has been outstanding, the long-term performance of EIA’s prototype indexes  has been equally as impressive. Each of EIA’s indexes applies the same rules-based approach to selecting stocks but starts from a different investment universe. The following exhibit shows the back-tested performance for three IFED indexes tracking different categories of market capitalization over the period from 1999 through November 2022.
Exhibit 2: IFED Index Long-term Performance (January 1999 through November 2022)
Exhibit 3 reports returns for the three IFED indexes relative to each indexes’ benchmark. The returns across the various holding periods support the robustness of the IFED strategy. Remarkably, each index outperformed its benchmark over each of the alternative holding periods.
Exhibit 3: Comparative Returns by Holding Period
The performance presented here confirms that the IFED strategy has been effective at producing alpha regardless of the starting universe of stocks. In general, the strategy has been most effective when provided with the greatest flexibility regarding stock selection i.e., when the starting universe is the broadest. IFED-A has the broadest investment universe, the 1,500 largest U.S. stocks, and reports the highest return in all but a few isolated cases. The superiority of these broad based IFED indexes supports the efficacy of the IFED philosophy, which contends that exposures to specific return drivers are optimal under certain market conditions. Starting with a universe containing stocks with the broadest set of features allows the model to create exposures that best align portfolio holdings with the market environment.
The IFED strategy is built around the principle that Fed policy signals reveal market environments that are conducive to securities with specific features. In implementing the IFED strategy, however, the EIA team does not attempt to predict future Fed actions or evaluate the wisdom of past Fed actions. Instead, we believe the optimal approach is to compose one’s portfolio with stocks that are best positioned to prosper in the signaled environment. While it may be entertaining to talk about what the Fed may do, or what the Fed should do, we think it is more productive to have a plan in place that accounts for what the Fed actually did.
The IFED strategy categorizes the market environment into one of three possible environments, Expansive, Restrictive or Indeterminate. Based on over 30 years of peer-reviewed academic research, the EIA team has identified a set of twelve financial metrics that establishes the stocks that are best positioned to prosper in each environment.
Does the Fed Lead or Lag the Market?
The EIA team believes that a shift in Fed policy serves as a precursor to a new market environment that favors firms with a unique set of features relative to those preferred in the prior environment. We believe Fed signals serve as a forward-looking indicator based on two fundamental characteristics of the Fed.
First, signaled shifts in Fed policy have implications for subsequent changes in the money supply, interest rate spreads and the level of reserves. The Fed controls the money supply, so it isn’t shocking to observe patterns in monetary and interest rate measures after the Fed signals a shift in its intentions. The following exhibit is excerpted from a peer-reviewed academic publication by EIA’s founders. The findings confirm significant changes in the most prominent monetary measures following a signaled Fed shift.
Exhibit 4: Fund Availability Across Market Environments
(Excerpted from Appendix A of Garcia-Feijoo, Jensen and Jensen, “Momentum and Funding Conditions,” Journal of Banking and Finance 88, 2018: 312-329.)
The Ted Spread equals the difference between the 3-month LIBOR rate and the 3-month T-bill rate. The 3 reported liquidity measures are defined in the article. ***, ** indicate the reported difference is statistically significant at the 1% or 5% level, respectively.
The data in Exhibit 4 confirms that Fed signals effectively differentiate subsequent periods with significantly different changes in fund availability. That is, assuming you know how to interpret the Fed’s signals. As expected, Expansive periods witness greater changes in fund availability relative to Indeterminate and Restrictive periods. The systematic patterns in fund availability provide an economic justification for the differential return premiums assigned to the 12 metric exposures across the three IFED market environments. Given the crucial role that fund availability plays in the spending behavior and financial decisions of consumers, businesses and investors, these findings support the economic validity of the IFED approach.
Second, the Fed operates under a dual mandate, which dictates that Fed policy be implemented such that it promotes full employment and maintains price stability. Thus, a shift in Fed policy occurs when the Fed believes that future developments on the employment or inflation front warrant a proactive shift in policy. In making policy shift decisions, the Fed relies on its economic models to predict future developments. The models incorporate all the historical data available to the Fed (both domestic and foreign and both public and nonpublic); the recent actions the Fed has taken in the financial markets; and the response that its recent and planned actions are likely to have on market participant behavior.
Note that investment strategies that rely on measures of macroeconomic data make investment decisions based on old data. These strategies are most effective at identifying the optimal strategy for the past period. In contrast, the IFED indicator reflects the anticipated economic developments that the Fed forecasts and the ramifications of recent and future Fed actions.
Don’t Fight the Fed – Invest with the Fed 
Most investors are familiar with the old saying in the financial markets, “don’t fight the Fed.” The team at EIA believes the more appropriate saying is, “don’t ignore the Fed.” The problem with the old adage is that even though it is well known, there is little known about what it means for one’s portfolio. The follow up question for investors that is never answered is, “how do I avoid fighting the Fed?” As a result of the uncertainty regarding how to avoid fighting the Fed, investors generally either ignore Fed policy when forming their portfolios, or they incorrectly incorporate Fed policy into their portfolios.
Based on years of peer-reviewed research, the EIA team documented that shifts in Fed policy provide reliable indicators of changes in the market environment. Based on this information, the team designed and implemented the IFED strategy, which effectively captures the return patterns that EIA’s founders documented. Investors for years have been cautioned not to fight the Fed, the EIA team developed the IFED strategy, which allows investors to take the logical next step and “Invest with the Fed.”
 Nasdaq IFED-L is a large cap U.S. equity index and is EIA’s first launched index. For more information on this index please see our latest fact sheet here. For more information on the IFED methodology, please visit our website at www.economicindexassociates.com
 EIA has calculated these IFED indexes each month since January 2020. EIA and Nasdaq are planning to publish them daily for prospective licensees using a third-party index calculator starting in 2023. For more information on these indexes please see our latest fact sheet here.
 EIA’s founders presented the underlying tenets of the IFED strategy in their book, Johnson, Jensen, Garcia-Feijoo, “Invest with the Fed,” McGraw Hill Inc. 2014.