The IFED Strategy and the Fed’s Dual Mandate: March, 2022

Updated: Mar 16

The IFED monetary indicator uses Fed policy signals to classify the market environment into one of three categories, Expansive, Indeterminate or Restrictive. An Expansive environment is represented by a period when the Fed signals a more accommodative future monetary policy, whereas a Restrictive environment corresponds with a period where the Fed signals tighter future policy. With an Indeterminate environment, the Fed’s policy signals are mixed.


The Fed’s dual mandate requires the Fed to consider two macro level variables when setting its monetary policy. Those variables are price stability (i.e., controlling inflation) and promoting full employment (i.e., encouraging economic growth).


The IFED monetary indicator relates directly to the Fed’s dual mandate by identifying the Fed’s first priority. During Expansive environments, the Fed focuses on the full employment component of its mandate, that is the Fed takes actions to maintain economic growth and help facilitate full employment, while allowing inflation to play a secondary role. When the environment is Restrictive, the Fed emphasizes price stability, and its actions are directed toward fighting inflation. An Indeterminate environment is witnessed by a period when the Fed emphasizes neither component over the other i.e., each component receives approximately equal consideration.


The IFED Strategy and the Federal Reserve’s Dual Mandate

In contrast to the views of most market participants, the IFED strategy identified a shift to an Expansive environment at the beginning of December 2021. Many market participants believed the most pressing concern at the time was inflation. Fed policy signals, however, suggested the Fed determined that inflation was not an imminent concern and supporting employment and economic growth took precedence. The IFED model adjusted accordingly by rebalancing in early December 2021.


The IFED strategy is a stock selection approach that is guided by Federal Reserve policy signals. The strategy relies on twelve firm-specific metrics to identify the portfolio of stocks best aligned with the prevailing market environment. The strategy does not target particular sectors; however, sector exposures tend to fluctuate in concert with shifts in the environment. These fluctuations occur due to the commonality of firm specific metrics across sectors. The following tables present summary information regarding the composition and characteristics of the IFED Large-Cap US Equity Index (IFED-L) before and after the December 9, 2021 rebalance. The IFED-L index was launched on June 9, 2020.


Largest Holdings and Sector Weights: Before and After December Rebalance
Portfolio Summary Statistics

In December 2021, the portfolio shifted substantially in correspondence with the shift from an Indeterminate environment to an Expansive environment. The new portfolio has greater growth prospects and more market risk than the prior portfolio. The largest changes in sector weightings are a shift to information technology and energy stocks and away from utilities, financials and industrials. The largest holdings went from two auto companies to a bank and an energy company.


The following table presents the performance of IFED-L over two alternative time periods, 1) since its launch on June 9, 2020, and 2) since its latest rebalance in December 2021. The returns are reported through month end February 2022.


IFED-L Performance, through February 2022

IFED-L has outperformed its benchmark (the S&P 500) by a substantial margin since its launch in June of 2020. This time period includes a wide variety of market events including a lingering and transforming pandemic and the outbreak of a war. The strong performance over this varied and tumultuous time supports the robustness of the IFED strategy.


IFED-L’s performance since its last rebalance in December 2021 reflects the strategy’s ability to capitalize on a tactical position. At year end, a prominent viewpoint among market participants was that inflation was the most pressing market concern. Based on Fed policy signals, however, the IFED strategy positioned the portfolio to tilt toward equities with strong profit margins and growth potential i.e., equities conducive for an Expansive environment. The result over the subsequent three months has been a total return of 6.37% versus the market return of -6.67%. EIA’s December commentary article noted our viewpoint that the environment shift at the beginning of December offered the opportunity to capitalize on a tactical shift in portfolio composition.


More often than not, the IFED strategy has been effective at capitalizing on such opportunities as witnessed by the long-run back-tested outperformance of the IFED-L index. As confirmation of the strategy’s long-run efficacy, the following figure depicts the 3-year and 5-year rolling alphas for IFED-L since 1999. Note that the number of periods of underperformance are few and far between. Furthermore, when short periods of underperformance occurred, they were small in size and were followed by periods of strong outperformance.