Market Turmoil Unfolding Largely as Expected

The dive in the equity markets coupled with the slide in the yields of treasuries is going largely as expected, as outlined in previous posts. A couple unanticipated trends included the sharp rise in gold and the rush of money headed to the Swiss Franc, although in hindsight both of these trends are logical as investors seek out places to hide.

As we likely go through the "thick" of the market turmoil over the next couple months it is important to layout the following: (1) clear signals to begin re-allocating assets, (2) identify potential investments in which to move, (3) a bail-out strategy should trends deviate from the expected.

Signals
As commentary on the markets increasing includes words like "emotion," "fear," and "uncertain," it likely suggests we are getting close to a capitulation. Another sign highlighted in the Wall Street Journal is that the benchmark M2 gauge of money supply spiked up 1.7% during the week ending August 1. This is both a sign of increasing panic and aversion to risk as investors move to cash positions, providing a deflationary pressure to economic growth. Additionally, investors removed $30 billion from equity mutual funds last week, suggesting more funds likely have to do forced selling and increasing the likelihood of downward pressure in the equity markets.

The clearest sign, in my opinion, is when yields on treasuries collapse, signalling desperate movement of money away from equities into treasuries. This may occur before the actual market bottom in equity markets since fundamentals may appear "not that bad" to equity holders. Sharp movements in yields often have severe ripple effects on currencies, debt markets, banks, and ultimately the economic outlook. So my plan is to sell into a panic buying of treasuries and begin establishing other positions.

Potential Investments
Specifically, I'm looking for quality companies at attractive valuations with a brightening outlook over the next year despite a potential economic slowdown. Ideally I would build a portfolio that likely benefits from the initial bounce back in the markets. So, from the top down one way to approach it is that I'm looking for U.S. companies positioned in more non-discretionary segments of the economy with opportunities ahead. An example might be Dunkin Donuts (ticker DNKN), a company hurt slightly during 2008 and with growth opportunities as it expands the number of units. Alternatively, a well managed company that could take market share in uncertain times whose customer base may provide choppy order flow, implying a high beta, but is healthy in a downturn. An example is Eaton Corp. (ticker ETN). Finally, looking for a company coming out of a negative period already that has scrubbed itself clean and sells into a healthy demand environment. An example would by WR Grace (ticker GRA).

Bailout Strategy
The markets are likely choppy going forward, implying there could be days and weeks in which the equity markets rally and provide a gut-check. If the yield on the 30-year treasury were to rise back above 3.75% I would begin to re-calculate my outlook. Since treasuries is over half my portfolio, it is the most obvious one for me on which to focus. It also offers a wealth of information about the economic outlook and money flows.