Boring Is the New Sexy

'Hot money' players are moving into traditional defensive stocks -- but how long will they stay in them?
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Market participants have sniffed out a turn in the economic cycle, and that has resulted in a change in leadership since early May. But much to the frustration of traditional and retail investors, the rising influence of the so-called fast-money players has accentuated both the positives and the negatives.

As the Bank of Japan moved to end its quantitative easing and the

Federal Reserve

failed to signal a pause on May 10, many hedge funds took their money out of riskier asset classes. Since then, they have increasingly joined the long-term investors by buying the once-benign tortoises of the stock market.

"We have been long consumer staples, food companies, utilities and pharma," says one hedge fund manager who declines to be named. "We're short industrials, and tech, and others were doing the same thing or similar trades," he says, adding that hedge funds primarily use ETFs, the indices and baskets of stocks to pursue the rotation.

But with 30% to 50% of trading on any given day driven by hedge funds, according to Mary Ann Bartels, chief markets analyst at Merrill Lynch, there could be plenty of risk in playing it safe.

In a sign of the new fast-money fashion, the "safe and boring" utilities sector touched an all-time high intraday Wednesday, while the broader market averages were led by consumer staples and other recession-proof stocks.

The

Dow Jones Industrial Average

closed up 0.7% to 11,199.93, while the

S&P 500

finished the day up 0.6% to close at 1278.55 and the

Nasdaq

gained 0.8% to 2078.81. The Dow Jones Utilities index closed down 0.04%, ending at 438.05, but reached 440.38 intraday. The market seemed to ignore the latest run-up in oil, which closed at $76.05 per barrel.

One of the ultimate defensive companies,

Procter & Gamble

(PG) - Get Report

, was one of the best performers Thursday. The company reported strong earnings, and its shares jumped 4.2%.

In other "unsexy" stock news,

AT&T

(T) - Get Report

,

Time Warner

(TWX)

,

Cigna

(CI) - Get Report

,

Mastercard

(MA) - Get Report

and

Clorox

(CLX) - Get Report

rallied after reporting quarterly results.

That these companies jumped on strong earnings is an oddity in this market. Throughout second-quarter earnings season, investors barely bought into companies that reported strong earnings, but they

punished companies that reported even narrow misses.

Esterline Technologies

(ESL)

and

Keystone Automotive

(KEYS) - Get Report

were Wednesday's examples, while

Avon Products

(AVP) - Get Report

suffered another 5.7% haircut after Tuesday's disappointment. (Meanwhile,

Starbucks'

(SBUX) - Get Report

shares were recently down more than 9% in after-hours trading after merely meeting expectations and reporting lower margins.)

It used to be that stocks would weaken 1% or 2% if they missed earnings, and investors would debate the strength of the company's fundamentals. Now, if a company misses, the reaction of hedge funds and other fast-money players can be brutally ruthless, which, in turn, can fuel additional selling by erstwhile long-term investors.

When a stock is down 10% or 20%, portfolio managers of a more traditional bent can't just sit back and weather the storm, even if they believe in the stock in the long term. "The client or consultant comes and says, 'This stock is down 20%, what are you doing about it?' and you can't not react," says Brett Gallagher, head of U.S. equities at Julius Baer Investment Management. "You can't say the market is wrong. You have to have an answer."

Gallagher, who defines short-term investors as "renters" and long-term investors as "owners," says "stocks that were renters performed well through April."

But sometime after May, the "owner" stocks ended up performing better, he says, adding that he isn't 100% sure that the renters have moved into the owner-oriented stocks, but recommends watching stocks' turnover rates -- available on a Bloomberg terminal or other trading systems. "One needs to be more cautious when the turnover period is very short," he writes.

According to his research, the highest turnovers are in tech and materials stocks, including semiconductor company

PMC-Sierra

(PMCS)

and

U.S. Steel

(X) - Get Report

.

Those with the least turnover are typically in the consumer staples, financials and pharmaceutical stocks, including beverage company

Brown-Forman

(BFB)

and

Citigroup

(C) - Get Report

.

Stocks in the S&P 500 with the shortest holding periods returned the least over the past six months, three months or even five days, according to Gallagher. Only in the first three months of the year did the highest-turnover stocks perform best, but that was because the whole market was embracing materials and small-cap "rentals."

Clearly, "it has become more important to know what fast money is doing," says Gallagher. "You spend your time looking for pearls and you end up spending more time fighting off the short-term players" whose presence has forced other investors to shorten their time horizons.

As the fast money has migrated into traditional defensive stocks, large speculators also spent the last couple of weeks covering short positions in the Treasury market, according to Merrill's Bartels. The Treasury bond market has rallied sharply of late -- which market participants take to mean the bond market is telegraphing expectations for a

Fed

rate pause. Hedge funds also are short the dollar and long the euro, a bet that may turn ugly if the Fed hikes next week.

On Wednesday, the 10-year Treasury bond gained 4/32 to yield 4.96%, while the five-year note gained 2/32 to yield 4.88% and the two-year Treasury bond was unchanged, yielding 4.95%. The dollar strengthened slightly Tuesday vs. the yen and the euro. The euro fell 0.31% to $1.2782, and the dollar gained 0.24% versus the yen to 114.66.

Whatever the market, the renters may become owners during times of transition, but they could be in it just for the flip.

In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click

here

to send her an email.