Edgy investors cling to defensive stocks

Investors are suddenly getting less brave as the recent selloff has tested their resolve, and fears that a correction could be coming get more real.

Skittish investors are skipping the exciting momentum stocks for now, instead jumping into the so-called defensive stocks – those deemed less likely to react to swings in the markets and the economy.

Not wanting to see their gains on big winners disappear, investors are shifting into defensive stocks until the market's turbulence goes away, says Sam Stovall of S&P Capital IQ. "Investors are being no better than hyperactive first graders playing musical chairs and waiting for the music to stop," he says.

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Signs of investors rush to be seated in defensive areas of the market is clear from:

• Outperformance of defensive sectors. Nowhere is the shift to defensive stocks more clear than in the relative strength of the utilities sector. During times of uncertainly, investors move to utilities, which are known for their stable earnings and dependable dividends. The Utilities Select Sector SPDR Fund is up 0.4% this year, escaping the market's 3.5% decline this year. Utilities, along with telecom stocks, are the only two of the 10 market sectors that are up on the year. Healthcare stocks, another area of safety, are down just 0.2%.

• Smackdown of stocks with rich valuations. Internet stocks, namely, the high-flying social media stocks, among the first stocks investors are selling. Twitter, which saw its shares soar last year from its November initial public offering price of $26 a share, are skidding. Shares of the online short message service is down 9% this year. "Stocks with the most weakness are those that were highly valued and fairly liquid and easy to trade," says Charles Crane of Douglass Winthrop Advisors.

• Move into defensive trades. Another telling sign of the sudden nervousness of investors is the jump into bonds. Investors have jumped into the 10-year ! Treasury, pushing prices up, and knocking the yield down from 3.03% at the start of the year to 2.77% now, says Todd Salamone of Schaeffer's Investment Research. Meanwhile, investors looking to lock in gains in case of market turbulence are loading up by buying investments that turn profitable if the market's volatility rises, Salamone says. If the market does get more volatile, these bets will turn profitable, causing the bulls on the other side of the trade to sell stocks, he says.

The rush to defensive stocks is understandable since investors know it's been 28 months since the last correction of 10% or more, Stovall says. Corrections, on average, occur every 12 months since World War II. "It's a matter of time," he says.

But while investors may be prudent to shift out of the riskiest areas of stocks, they're not bailing out, Salamone says. Biotech and solar stocks, traditionally risky areas, are still outperforming this year. It's just that investors are starting to keep plans in place if the market turns uglier.

"Everyone is protecting against the correction everyone is calling for," he says. "But if you're a long-term investor, it's too early to sell."