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Summers out, sentiment up, so watch out: Yoshikami

Monday, 16 Sep 2013 | 10:17 AM ET
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Larry Summers chose to abandon his lifelong goal of chairing the Federal Reserve this week.

What many do not know is that Mr. Summers comes from parents who were economists and relatives in his family won the Nobel Peace Prize for economics. Surely this would have been the ultimate goal for Mr. Summers; for the time being that possibility is gone.

With that possibility eliminated, now will come a burst of optimism that quantitative easing will not be decelerated beyond the current Fed slow tapering strategy.

Mr. Summers was a wild card; Janet Yellen is not. As vice chair of the Federal Reserve, she is currently on board with the current policy and the markets will no doubt breathe a huge sigh of relief.

Are markets set up for a wild week of trading?
Kevin Giddis, Raymond James; Matt Smith, Schneider Electric, and Boris Schlossberg, BK Asset Management, provide a preview of this week's trading activity in currencies, energy and fixed income, after Larry Summers withdrew from the race for Federal Reserve chairman.

(Read more: Stocks surge, yields dip on shocking Summers news)

The 10-year Treasury (which recently crossed the 3 percent yield point) could very well rally in price as sentiment moves toward more of a belief the Fed action will be muted and gradual.

That means a longer drawn-out withdrawal process for QE will likely now be in the cards. This also means that artificial stimulus efforts to keep the economy alive will remain in place which is likely bullish for both for stocks as well as bonds.

Market movements that you will see this week because of this withdrawal announcement are all about psychology and expectations and have very little to do with current data.

When expectations and fear are driving forces (as they will be in the fixed income markets over the coming days), you need to recognize that rational thinking must be combined with a recognition that sentiment is alive and well.

(Read more: Wall Street wanted Yellen anyway: CNBC survey)

Fear has driven fixed income markets down and equity markets have been incredibly volatile because of concerns about Fed action. Volatility won't go away but you will see some reduction in fluctuation. Watch for the CBOE Volatility Index to take a hit.

If you are a short-term investor, you need to recognize that your ability to forecast accurately headlines in the short term continues to be your No. 1 priority. If you're a long-term investor, understand that the short term is going to greatly influence your strategy even if the data support your view for the long term. Don't panic!

If you have a hybrid view, you need to understand what percentage of your strategy is long term versus short term. And when the winds of fear and euphoria come blowing, you better stick to your strategy at that point.

The reason why this is so important is that many investors act in direct opposition to their stated investment philosophy at the worst possible moment. Have you ever known a long-term investor to panic and suddenly sell because of short-term price movements? It happens all the time and the result is usually disastrous.

(Read more: Fed is 'tapering,' but that's the easy part)

Likewise, short-term investors sometimes abandon their philosophy and become emotional when they are wrong about a recent headline. As a short-term investor you can't get caught up in being right all the time; reality is you will have some hits and misses and you need to trade in a way where you don't destroy your portfolio if you're wrong. You need to limit your losses.

If you use a combination of both perspectives, identify which assets in your portfolio are long-term positions and which have a more short-term perspective. Each component should have a specific role and you need to know what those roles are.

So watch market movements this week.

It should be quite a ride and confirm our contention that markets are not as rational as everyone thinks. And since that's the case, you need to make sure your portfolio strategy reflects your perspective and that the psychology of the markets does not overcome your emotions.

Let that happen to others; not you.

Michael Yoshikami is the CEO and founder of the investment committee of Destination Wealth Management.


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