This strategy follows the Fed's stance and allocates its assets in three equal parts-large/small stocks, gold/Treasury bonds and intermediate government notes. It aims to achieve a higher return while lowering risks.

This strategy is simply based on the fed monetary policy—to follow the Fed. Research shows that big caps behave better than small caps when money is tight while small caps outperform big caps when money is easy. Similar relationship is also found in gold and Treasury bonds. Gold is doing better than Treasury bonds when the Fed’s easy, and vice versa. Switching between large and small stocks, gold and Treasury bonds depends on the Fed’s monetary policy.

To lower the risk still further, simple intermediate government notes are added to the portfolio. Thus this strategy allocates assets equally among large/small stocks, gold/Treasury bonds and intermediate government notes.

1.     Determine whether money is tight or easy

• The indicator we use is T-bill –12m value minus Inflation–12m value, as described in the articles. If the former is larger than the latter, then Fed's money policy is tight.
• The T-bill–12m is the trailing 12 - month compound return using the last twelve monthly “T - bill” values.
• Similarly the Inflation–12m measures the trailing 12-month compound return using the last 12- month inflation values. Inflation is calculated as the change in CPI index between this month and last month divided by last month’s CPI index. Here CPI index is referred to CPIAUCSL-Consumer Price Index For All Urban Consumers: All Items
• We can also compare the above indicator value with the 64-day simple moving average value of the indicator. If the former is larger than the latter, then the Fed's tight, and vice versa.
• We also create another indicator—short term interest rate minus CPI—to determine the money status. If the indicator value is above 0, then Fed’s tight. The 64-day simple moving average of the indicator value can also served as an alternative threshold value.

2.     Portfolios

• If money is tight, the portfolio is composed of:
  • 33.33% in large stocks
  • 33.33% in Treasury bonds
  • 33.33% in intermediate government notes
• If money is easy, the portfolio is made up of:
  • 33.33% in small stocks
  • 33.33% in gold
  • 33.33% in intermediate government notes

3.  Switching frequency

The strategy adjusts portfolios every month according to the money status.

• If short-term T-bill rate remains higher/lower than inflation, no adjustment is made to the portfolio because money remains tight/easy.
• Similarly, if the indicator value stays above/below 0, or it’s higher/lower than the 64-day simple moving average value of the indicator, no adjustment needs to be done to the portfolio.
• However, if the money status changes, for example, money is tight right now while it was easy last time, investors must adjust the portfolio accordingly. In this case, portfolios should be switched to the other type so that investors can achieve higher returns while remaining lower risks.

4.  Model portfolios

We have four model portfolios, based on the above-mentioned  ways how money status is determined. The performance of all the portfolios is measured from 01/01/1997 to 07/17/2009.

• The first portfolio achieves a Sharpe ratio of 0.482 and a standard deviation of 0.088, using 0 as the threshold value of the indicator-T-bill –12m value minus Inflation–12m value.
• The second portfolio uses the same indicator as the first one, but uses the 64-day simple moving average value of the indicator as threshold value.Its Sharpe ratio is 0.814 and the standard deviation is 0.092, indicating higher return and greater risk than the first one.
• The third portfolio uses our created indicator-short term interest rate minus CPI, and the threshold value is 0. The Sharpe ratio and standard deviation is 0.486 and 0.088 respectively.
• The last portfolio uses the same indicator as the third one, but uses 64-day simple moving average of the indicator as the threshold value. It achieves a Sharpe ratio of 0.82 and the standard deviation is 0.093.

 Funds used in the strategy:

• Large cap:  VFINX- an index fund tracking the performance of the Standard & Poor's 500 index
• Small cap: NAESX-an index fund tracking the performance of the MSCI US Small Cap 1750 index
• Gold:  GLD-a trust seeking to strive to reflect the performance of the price of gold bullion
• Long term treasury:  VUSTX - a index fund investing at least 80% of assets in U.S. Treasury securities with a average weighted maturity ranging from 15 to 30 years
• Intermediate term treasury:  VFITX - an index fund investing at least 80% of assets in U.S. Treasury securities with a average weighted maturity ranging from 5 to 10 years.

See Also

• Forsyth, Randall, "Seeking the Holy Grail of the Investing", Barrons.com, Up and Down Wall Street Daily, June 23, 2009.
• Forsyth, Randall, "To Enjoy Life, Just Buy Big-Caps", Barrons.com, Up and Down Wall Street Daily, December 22, 2006.
• Doug Roberts, "Follow the Fed to Investment Success: The Effortless Strategy for Beating Wall Street", Wiley, May 2, 2008. Detailed strategy description could be found in Chapter 11.
• Doug Roberts, "Follow the Fed Strategies", Channel Capital Research. It offers basic strategies for free. Otherwise, one needs to become a premium member to access more advanced strategies.