Clayton Gardner sends: What a week it was for markets around the world. With major U.S. indices dropping 4-5%, Brazil down over 5%, and Shanghai at an all-time high, we’ve see some of the worst and best in stocks, bonds, and derivatives. What we saw this week was the first real sign that a non-bullish thesis has a spot in the minds of traders, and that has far-reaching implications beyond just U.S. equities.

Let me start by sorting out some of the complicated credit and subprime issues that have been hanging on the wall while the market partied on. Many investors threw up their arms in panic as the markets opened this week, sending the CBOE Volatility Index (VIX) soaring 35% to 52-week highs, as concerns about the inability of investment banks to refinance bridge loans to third parties spurred fears of a dry up in liquidity. The shift (or lackthereof) of credit, and hence risk, led to the re-pricing of many financial assets and is one reason why financials led the markets lower. The sell-off we saw was across the board though, and shows that this is more than just a credit event that the Street is dealing with. Tech stocks took a beating as well, and their relative independence from financing tells me this has a risk angle as well, and the drubbing in energy and materials stocks like Exxon Mobil (XOM, down 7% this week) and Alcoa (AA, down 11%) show that data is bringing into question the strength of the economy that drives these cyclicals; this is a bit confusing considering we received an excellent GDP number. What to make of all this? Although traders rushed in near the close on some huge down days to pick up beaten equities, most value and growth investors stayed their distance and let stocks come in, showing signs of risk aversion and tepid enthusiasm. Now is a reasonable time to answer questions like “will housing and subprime fallouts hurt every stock I own? “Should I liquidate all of my positions and cut my losses now, or will the market pop and soar soon?” If you don’t have some reasonable answer, you won’t have the conviction to stay in your positions and run the risk of getting out at exactly the wrong time. Here is my analysis of the issues, and what investors should be doing.

Some simple sector analysis will show that in the past few bear rallies, tech has outperformed some of the biggest booming bull markets of the year. In retrospect, I find it quite odd that tech outperformed other market sectors on such a bearish day, as technology usually underperforms when risk rises across markets. Looking closer though, I noticed that industrials and emerging markets have been under extreme pressure lately (industrials have lost 4-6% of recent gains, and foreign markets like Brazil and Germany have lost up to 6% and 4% respectively in intra-day trading recently, in response to slower growth forecasts from their parts of the globe). Other European markets have also fallen 2%+, as the global re-pricing of credit stirs worries of drying liquidity. Despite all of this negativity, I beg to differ with the bears’ argument that we are entering a global recession. Fundamentals remain strong throughout the world markets; this week’s correction was simply based on the fact that assets are somewhat difficult to value as risk and volatility gyrate. I have always been geared toward more value investing, but the recent market movements indicate that the market cycle is now switching to growth-based models. The Nasdaq-100 (NDX) was up over 35% in the last year, well ahead of the S&P 500 or Dow Industrials. This index of predominantly large-cap tech names, even in the midst of recent bearish sentiment, has not broken through its 50-day moving average, which is a great sign of technical support. Fundamentally, strong profit growth heals most wounds, and continued double-digit earnings growth on the corporate side, helped by a Goldilocks 2.25-3.25% GDP growth, will support the market going forward, even in the face of worries brought on by our nation’s trade deficit, plunging dollar, and inflation threats.

Moving to private equity, bondholders have been very angry as of late, calling for greater premiums and refusing to continually finance deals even as treasury yields fall (10-years yield only 4.785% now) and PE executives take their partnerships public to cash out their stakes and reap huge rewards. My biggest worry in the upcoming weeks and even months is that outstanding credit derivatives will weigh down banks and brokers even to the point of spreading to other industries. As I stated earlier, bondholders have already refused to continue funding leveraged buyouts and acquisitions, and the liabilities of loans are now placed solely on the shoulders of already-risk-conscious banks and brokers. On top of risk issues, non-commercial loans are continually harder to write as well, as mortgage brokers are tightening lending standards as part of a reaction the rubber-stamp loan approval period of just two years ago. All this could combine to send earnings at interest-dependent financial institutions down, while correspondingly raising the levels of liabilities held on the balance sheet… a scenario that sounds vaguely like what we are seeing with homebuilders. With the huge weighting financials have on the major indicies, this would obviously be a bad development for the markets.

Enough rambling about the economy though… it’s time to reveal my stock picks to play this rally safe, while profiting heavily when the correction bottoms. Though fairly conservative, I find these stocks to be undervalued and well-positioned to capitalize on advantageous business conditions: Varian Semiconductor (VSEA), Lockheed Martin (LMT), Boeing (BA), Cisco (CSCO), Apple (AAPL), Research in Motion (RIMM), United Technologies (UTX), Kellogg (K), General Mills (GIS), and General Electric (GE). While many of those stocks have been popular picks for much of the last decade, many investors ignore these stable growth plays as they search for more exciting and speculative names that can deliver marvelous returns. Right now, the prudent course is to stick with tried-and-true names that are being undeservedly thrown out with everything else; buy high-quality tech, defense, and consumer staples that are levered to international markets and ride out the market’s correction. You can also read my Resilient 25 Stock Picks for more defensive names that nonetheless offer great upside potential.