Cyclical stocks are high-profit but volatile stocks that rise and fall as the economy grows and declines. This sensitivity is due to the effects of economic contraction, which forces many people to spend less on particular goods or services. Cyclical stocks are usually part of industries that are dependent on discretionary spending, such as entertainment, travel, and luxury retail. They have the potential to provide higher-than-market-average returns but need to be carefully timed.
If you’re a long-time investor, then you probably know just how much the economy can affect your stock portfolio. When the economy is booming, as it has been for much of the past decade, stocks generally rise in value. But when the economy takes a turn for the worse, so does the stock market.
There are certain stocks, known as cyclical stocks, that tend to be more sensitive to economic changes than others. These securities do really well when the economy is on the rise but tend to lose value during economic downturns. In this article, we discuss what cyclical stocks are, how they differ from defensive stocks, and how the different roles they can play in an investment strategy.
What is a cyclical stock?
Cyclical stocks are those whose performance is affected by the broader economy. When the economy does well, and consumers spend money, cyclical stocks increase in value. But during times of economic downturn, cyclical stocks tend to lose value.
Cyclical stocks can be found across many different sectors and industries, and they come in companies of all sizes. Within the category of cyclical stocks, some may be more or less sensitive to economic factors than others. However, the key similarity between them all is how they rise and fall with the economic cycle (i.e. expansion, peak, contraction, and trough).
Cyclical companies tend to sell those products that are non-necessities. People spend more money on them when the economy is doing well but may cut back during a recession, such as automobiles, travel, and home goods.
How does the stock market cycle affect this growth?
The market moves in economic cycles with four different stages: expansion, peak, contraction, and trough.
- Expansion. This is the time of economic growth, often for a long period of time.
- Peak. When the expansion ends, it does so at the peak, which is when the economy has grown to its high point and begins to reverse course.
- Contraction. The contraction is the period of decline, which could be a recession.
- Trough. This is the economy’s low point, after which it begins recovering again.
These four economic stages affect companies across the entire stock market but may do so differently. Cyclical stocks, in particular, tend to perform well during times of expansion. But once the economy takes a turn and begins its contraction, cyclical stock values turn with it.
What are different examples of cyclical stocks?
Cyclical stocks are generally those from businesses that consumers tend to spend less on when the economy does poorly. To understand this, let’s explore the sectors and industries with the stock market itself.
Cyclical stock sectors
The stock market is broken down into 11 different sectors, each of which is separated into several different industries and many companies. The 11 sectors are:
|1. Consumer discretionary||7. Industrials|
|2. Consumer staples||8. Materials|
|3. Energy||9. Technology|
|4. Financials||10. Utilities|
|5. Real estate||11. Communication services|
|6. Health care|
Looking at this list, likely the most obvious cyclical sector is the consumer discretionary, which is made up of those non-essential items that people tend to buy when the economy does well. Cyclical sectors also include materials, financial services, and real estate.
Other sectors are sensitive to economic changes, but not as much as cyclical stocks. People will continue to spend money on these sectors no matter how the economy is doing but may spend less when the economy isn’t doing well. Those sectors include communication services, energy, industrials, and technology.
Cyclical stock industries
Within each stock market sector are a variety of industries and companies that make it up. Even within a particular sector, some companies may be more cyclical than others. Here are some examples of cyclical industries you’d find within the sectors we discussed above.
- Automobiles. Vehicles themselves are essential, but people may be more likely to buy new cars when the economy is booming versus when it’s doing poorly.
- Airlines and hotels. Travel tends to decline during an economic slowdown, which especially impacts the airline and hotel industries.
- Restaurants. Dining out is considered non-essential for most families, who tend to cut down on money spent at restaurants during tough economic times.
- Retail. Spending overall tends to decrease when the economy is down. People buy fewer clothes, household goods, and other non-essential purchases.
- Technology. People need technology no matter how the economy does. However, they’re less likely to splurge on the latest popular iPhone or smartwatch during a recession.
- Real estate. The housing market is highly cyclical, especially since a home is such a large purchase. When the economy does poorly, fewer people buy homes.
- Financial institutions. Just as people buy fewer homes when the economy is poor, they’re also borrowing less in general from the banks, including auto loans and credit cards.
What are the best cyclical stocks to invest in?
There are countless cyclical stocks you can add to your portfolio. Rather than choosing individual stocks, you can add sector funds or cyclical funds to your portfolio, which give you broad exposure to a wider range of cyclical stocks.
If you still have questions about the best cyclical stocks for your portfolio, you may want to consider looking for a brokerage. Using the information below, you can compare brokerages and find the best match for your experience and interests.
Cyclical vs. non-cyclical stocks
Just as there are securities that are highly sensitive to changes in the economy, others aren’t quite as sensitive. Those non-cyclical stocks — also known as defensive stocks — may decline somewhat during a recession. But they aren’t as affected by changes in the economy.
Non-cyclical stocks fall into those sectors and industries that people continue spending money in no matter what happens with the overall economy. Here are a few examples:
- Food. No matter how the economy is doing, people have to buy food. While people’s individual food choices may change slightly, the industry is non-cyclical.
- Household and personal products. People continue to buy household and personal care products throughout both economic expansion and contraction.
- Healthcare. It’s probably no surprise that healthcare is a non-cyclical industry. People continue to visit the doctor and spend money on medical supplies regardless of economic trends.
- Utilities. This category includes gas, electric, and water utilities, which remain largely unaffected by changes in the economy.
As you may have guessed, non-cyclical stocks tend to outperform many cyclical stocks in general during times of economic uncertainty. But when the economy is booming, and cyclical stocks are doing exceptionally well, defensive stocks are likely to underperform. It’s not that people aren’t spending money on them during times of economic expansion. Rather spending doesn’t increase in the same way it does for cyclical stocks.
Pros and cons of investing in cyclical stocks
There are plenty of benefits of including cyclical stocks in your portfolio, but there are also some downsides. It’s important to understand both if you plan to invest in cyclical stocks.
Here is a list of the benefits and drawbacks to consider.
- High performance. One major benefit to including cyclical stocks in your portfolio is the potential for growth they provide. These securities perform well when the economy is doing well, and tend to outperform the market overall.
- Discount price. If you buy cyclical stocks after a market contraction and during a trough, you can get them for, essentially, a discount. As the economy recovers, their prices are likely to bounce back strongly.
- Diversify. Investing in cyclical businesses is a way to diversify your portfolio. When you have a healthy mix of both cyclical and defensive stocks, you can hedge your risk for when the economy starts to dip but increase your returns in a booming economy.
- Sensitivity. The biggest downside of cyclical stocks, as you can probably guess, is their sensitivity to the economy. Unfortunately, when the economy is contracting, you can expect that your cyclical stocks will lose value, even more so than other types of companies.
- Daily changes. Not only are cyclical stocks more sensitive to changes in the economy, but they may also experience more volatility on a day-to-day basis. Since most investors find it nearly impossible to time the market, it may be difficult to time your buys and sells with this volatility.
Should you invest in these stocks?
While it’s true that cyclical stocks can be higher-risk than defensive stocks, they also have plenty of benefits. When the economy is doing well, cyclical stocks outperform defensive stocks. It’s important to have a diversified portfolio of both cyclical and non-cyclical stocks to take advantage of the benefits of both.
- Cyclical stocks are those that are most sensitive to changes in the economy. They perform well during economic expansion and lose value when the economy slows.
- These stocks fall into categories of non-essential goods that people tend to spend less money on during a recession.
- The opposite of a cyclical stock is a non-cyclical stock, also known as a defensive stock. These stocks are less sensitive to changes in the market.
- Both cyclical and non-cyclical stocks have their pros and cons, and it’s important to build a diversified investment portfolio that includes both.
View Article Sources
- Your Investment Options — New York State Office
- Types of Stock — Texas State Securities Board
- How To Invest In The Stock Market: 8 Basic Concepts — SuperMoney
- Best Online Brokers for Stock Trading in 2022 — SuperMoney
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- Brokerages: Reviews & Comparisons — SuperMoney