In my first lesson, “Trading Greenspan, Part I," I described the best way to trade Greenspan during the two months when he delivers his Humphrey-Hawkins testimony. But what about the other ten months? The first step is to recognize that when Greenspan delivers a policy speech, the impact can span several months. As I said before, this is because Fed policy doesn’t change on a dime. Thus, once the Fed’s policies become clear, the markets behave as though they assume that these policies will be in place for a while. Your trading strategies, therefore, should evolve around the notion that Fed pronouncements have lasting impact.

But how can we decipher where Fed policy stands on a regular basis? I suggest you become a regular Fed watcher. Get in their shadows, in other words. Being a Fed watcher is actually quite simple. What it boils down to is merely tracking the verbiage spewed by the FOMC—that cast of 13, including Greenspan, who vote on whether to raise or lower interest rates at FOMC meetings (held eight times per year). There are five additional Federal Reserve officials who attend the Fed’s meetings, but they vote only every other year (they are in essence the proverbial flies-on-the-wall at the FOMC meetings). While their views matter, too, keep your focus on the voting members.

To get you comfortable with Fed watching, think about it this way: let’s say that you’ve been asked to solve a mystery where all the principal players are known; they talk all the time; you get a plethora of clues about what they’re thinking; they give you verbatim transcripts of what they say; and they give you the minutes from all of their policy meetings. I’ll bet you can crack that mystery in a jiffy. Seen in this light, Fed watching looks pretty well-defined and far less intimidating than most perceive it.

One of the things that I often tell people to do, and that I find many top investors already do, is to read the text of the Fed’s speeches. It is not all that laborious since most speeches are just a few pages long. Reading their speeches gives you far greater insight than if you simply read headlines from newswires that largely reflect a reporter’s subjective view about the speeches. I strongly believe that no investor should leave it up to reporters to tell them what they should be thinking about what the Fed said; it is up to you. It is perilous to leave it in the hands of reporters, who often have very little background on the financial markets and, quite frankly, can be novices. Do the work yourself and you will find a dramatic improvement in your mastery over the state of Fed policy.

What should you look for when you are reading the text? I look for key phrases that are repeated in lockstep by several Fed members. When I see a particular phrase used either verbatim or nearly so by a few members, I always sense that the phrase is a representation of current Fed policy. When this happens, I envision Fed members meeting with each other, either in person or by telephone conference, drawing conclusions about where they stand on policy. This then finds its way into their public comments. Of course, all Fed members have their own personal views that they freely express, but this helps us in the battle to interpret the Fed’s public comments. How? Basically, if there’s consistency in the use of phraseology by members known to have bipolar views on monetary policy (just as a democrat and republican would on the issue of tax cuts), then their joint use of a particular phrase is generally a strong indication of agreement over where the Fed stands on a particular issue.

Last year, for example, just before the Fed began its most recent rate hike cycle, several Fed members repeatedly used the phrase, “the balance of risks have shifted (toward higher inflation).” Their common use of this phrase told me that the Fed was in the midst of formulating a new policy designed to counter those risks. This, of course, meant that rate hikes were on the way and they did indeed follow.

It is always striking to me to think that if I simply follow the words of a handful of people (the Fed), I can gain insights that I believe give me an edge on millions of investors. That is why I always include the Fed in my required readings.

Greenspan the Chameleon

Now that I have given you insights into Trading Greenspan, there is one last thing to keep in mind: Greenspan is a chameleon. He changes his stripes all the time. He has savoir-faire—he knows the right thing to do at the right time. Dogma toward policies that can get quickly outdated or outmoded doesn’t bog him down. One minute he is the champion of a particular economic model, the next he scraps it. Greenspan has an indelible record in this regard and it has served both he and the American economy well. You need simply avoid getting mired in the belief that you have Greenspan all figured out. Greenspan’s views, you see, evolve with the times.

The best example of this, of course, was his recent near-total abandonment of the traditional view that strong economic growth leads to inflation. This critical shift gave him the presence of mind to “permit” the economy to grow at an average rate of more than 4% over the past four years, a rate long considered to be well above the 2.5% speed limit that the Fed has historically used as their guide in the formulation of monetary policy.

Greenspan deftly saw that things were indeed different this time. He sensed that the implementation of new technology and innovations had changed the rules of the game. Greenspan, therefore, became more tolerant of strong growth than his past record would have led you to believe. Incredibly, Greenspan saw that the current period might be, as he called it, a “once-in-a-century period of innovation.” Once-in-a-century indeed. That’s an appellation that belongs to Greenspan.

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