Nine Stocks for Playing the Long Side Safely

Some of my long-term macro themes -- rising inflation, slowing economy, subpar job creation, and ongoing drag from the housing slowdown -- have been causing some turmoil in the markets lately.

Heading into Friday's trading, we look set to have the worst weekly decline in more than three months, a decline that has caused a short-term spike in volatility.

Despite this -- or perhaps, because of it -- we've gotten a number of inquiries from our clients, who range from rapid-fire traders to long-term investors and everyone in between, and I'm getting some variation of the same email from each of them:

I am afraid this market is overvalued, over-extended, and overdue for a major correction -- but I want to play from the long side (variation: I cannot afford to fall behind my benchmark). How can I participate in a way that is relatively safe, but still allows me upside?

When everyone starts asking you the same question -- regardless of their trading style -- it makes you sit up and pay attention. Even the tone of the emails are surprisingly similar. On the one hand, they evince a grudging respect for the strength of the recent market trend; at the same time, there is a recognition of the disconnect between the domestic economy's slowing growth and stubbornly "sticky" inflation, and the near-relentless bid for equities. (The past few days notwithstanding.)

That ongoing dynamic of good ol' fear and greed prompted me to put together the following long equity screen where I try to find ways to play the long side of this market safely. Now, before you scream "Capitulation!" please recognize that many of my institutional clients use their own investment models, and those styles are often quite different from my firm's. Applying a different approach to your methodology can discern between two good ideas or expose a glaring weakness. Looking at the technicals of a value portfolio, or screening for potential short squeezes in a Long/Short fund is merely another way to compete.

To answer the question of how to "play the market" in a way that is much safer than merely chasing momentum names as the market climbs higher, I set up a few qualifiers. Since my firm is essentially a quant shop -- we rely exclusively on a quantitative ranking system for stock selection -- we identified these half-dozen parameters:

1) Identify strong sectors with good money flow;
2) Screen for stocks with the best technical and fundamental potential;
3) Look for stocks within those sectors with desirable risk/reward characteristics;
4) Find stocks that are near good entry points;
5) Avoid the "runaway momentum" names;
6) Look for stop-loss protection that is a reasonable percentage downside away.

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At the time of publication, Ritholtz was long AOC, IO, SCI, XRX, SCHW, SGP, ABT and WCRX, although holdings can change at any time.

Barry Ritholtz is the chief market strategist for Ritholtz Research, an independent institutional research firm, specializing in the analysis of macroeconomic trends and the capital markets. The firm's variant perspectives are applied to the fixed income, equity and commodity markets, both domestically and internationally. Other areas of research coverage also include consumer, real estate, geopolitics, technology and digital media. Ritholtz is also president of Ritholtz Capital Partners (RCP), a New York based hedge fund. RCP is driven by the analysis performed by Ritholtz Research. Ritholtz appreciates your feedback; click here to send him an email.