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Yoshikami: Trade on Momentum or Fundamentals?

Tuesday, 29 Jan 2013 | 12:58 PM ET
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Stocks on the long-term trade based on fundamentals. Fundamentals are defined as the cash flow the position provides over a longer period of time. Fundamentals are a foundation of investing and most market participants look at this closely when making investment decisions. Warren Buffett of Berkshire Hathaway has used this over a long period of time to provide excellent results to Berkshire Hathaway shareholders.

But it's clear that momentum cannot be ignored as it does impact the movement of asset prices.

While it is dangerous (and not appropriate for most investors) to look solely at momentum as a trading trigger, we do believe it is important to recognize how sentiment effects the price of assets.

It's also important to recognize that assets that have strong fundamentals on the long-term often trade irrationally on a momentum basis. It's why a company that slightly misses earnings (but with great future business prospects) might trade down significantly so because of short-term momentum. Short-term price movements are driven by traders with shorter-term time horizons (often less than a year), and this can cause noise in the price of shares and in the value of assets in the marketplace.

China is a perfect example of sentiment versus fundamentals.

Last year China returns were dismal up until the last three weeks of the year when the Shanghai and Hang Seng market rallied strongly. It might have been an easy choice to become despondent about short-term momentum and abandon emerging market investments. But investors that focused on fundamentals (and held through negative sentiment) were rewarded.

Apple also provides an illuminating example. After reaching a high of $700 per share, the stock dropped to a level not seen for 12 months. The fundamentals are still intact for the company with growing China sales, a $13 billion quarterly profit, and the sale of almost 50 million iPhones during the most recent quarter. Still, the market punished the stock for a so-called disappointing earnings report. The momentum crowd is punishing the shares. But fundamental investors are still focused on the long-term and believe shares will bounce back.

(Read More: Apple 'A Broken Company': Gundlach)

It takes discipline but that's the key in investing; not letting momentum overwhelms fundamentals so that the long-term thesis has time to play out. That's a benefit of having a five year time horizon when assets are purchased; the noise impact is diminished.

This is not to say that momentum should be ignored; it has a role in portfolio strategy. It can guide the entry and exit in and out of positions. But while it has a role in tactically adjusting portfolio strategies, it should not be the only focus unless you are a trader and not an investor.

(Read More: Wall Street Uncertain When & How QE Ends)

Michael Yoshikami, Ph.D., CFP, is CEO, Founder and Chairman of the DWM Investment Committee at Destination Wealth Management. Michael is a CNBC Contributor and appears regularly on the network. DWM is a San Francisco Bay Area-based independent money management firm that provides fee-based wealth management services to institutions and individuals around the world. Michael was named by Barron's as one of the Top 100 Independent Financial Advisors for 2009, 2010, 2011 and 2012.

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