Summers Bows Out

Equity markets jumped higher Monday as Federal Reserve Chairman frontrunner Larry Summers ended his pursuit of the position. The news suggested Summers had been President Obama’s preferred successor to current Chairman Ben Bernanke, but several Democratic senators opposed the nomination, and Summers may be bowing out to avoid any chance of embarrassment.

With Summers out of contention, Fed Vice-Chair Janet Yellen is the clear frontrunner. As we’ve mentioned before, Yellen is viewed as a consensus builder and receives credit for predicting the housing bubble. Powerful Democratic Massachusetts Senator Elizabeth Warren, who sits on the Senate Banking Committee, supports Yellen and indicated that she would be able to gather the necessary votes for her nomination.

Regardless of the politics behind the decision, the Fed continues to hold tremendous power over public equity markets given its power to move interest rates and control monetary policy. Summers likely would have deviated from Bernanke’s existing quantitative easing policies, and his background in financial services suggests he could have been more lenient with respect to banking regulation.

On the other hand, Yellen may continue Bernanke’s quantitative easing policies, and the consensus opinion expects her to pursue similar monetary policy goals. We believe it would be shortsighted to say she will behave just as Bernanke would—obviously they are different people, and there is always the temptation to carve out differentiation from one’s predecessor. It should be clear that Yellen is a change from Bernanke, but maybe not as big of a change as Summers would have been.

If there’s anything markets love, it is certainty. With Yellen seen as largely the only nominee at this point, we expect to see less volatility in bond markets and in financial services companies. Further, the announcement reduces the probability of a large move in equity markets if/when she is officially nominated, in our view. More importantly, let’s recall the major differentiator, personality-wise, between the two: Summers is seen as arrogant and headstrong while Yellen is the consensus builder. Tension within the Fed and between the Fed and other political interests seemed all but certain under Summers, while Yellen will likely work to reduce friction as much as possible. The last thing investors want is more political gridlock.

Valuentum’s Take

At the end of the day, the Fed plays a large role in financial markets and incentivizing the behavior of consumers and financial institutions. Though its decisions can have lasting implications, whether Yellen or Summers is Fed Chair is secondary to the fundamentals of individual companies. Yellen, for example, can’t directly lower the cost to produce Apple’s iPhone 5C (click ticker for report: ) or make teens rush to American Eagle (click ticker for report: ).

Though some of our holdings, namely the SPDR S&P Banks ETF (KBE) and SPDR Financial Services ETF (XLF) will be impacted by Federal Reserve leadership, our strategy remains focused on finding undervalued stocks with strong fundamentals and positive technical/momentum indicators for addition to the portfolio of our Best Ideas Newsletter.