What Are Cyclical Stocks?
Cyclical stocks are stocks that tend to follow trends in the broader economic cycle, with returns fluctuating as the market moves through upturns and downturns. A cyclical stock is the opposite of a defensive stock, which tends to offer more consistent returns regardless of macroeconomic trends.
Investing in cyclical stocks could be rewarding during periods of economic prosperity. During a recession, however, certain types of cyclical stocks may suffer if consumers are spending less.
What Is a Cyclical Stock?
The stock market is not static; it moves in cycles that often mirror the broader economy. To understand cyclical stocks, it helps to understand how the market changes over time, with the understanding that this has a different impact on different types of stocks.
A single stock market cycle involves four phases:
Accumulation (trough)
After reaching a bottom, the accumulation phase signals the start of a bull market and increased buying activity among investors.
Markup (expansion)
During the markup phase more investors may begin pouring money into the market, pushing stock valuations up.
Distribution (peak)
During this phase, investors begin to sell the securities they’ve accumulated, and market sentiment may begin to turn neutral or bearish.
Markdown (contraction)
The final phase of the cycle stock is a market downturn, when prices begin to significantly decline until reaching a bottom, at which point a new market cycle begins.
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Cyclical Stocks Examples
The cyclicality of a stock depends on how they react to economic changes. The more sensitive a stock is to shifting economic trends, the more likely investors would consider it cyclical. Some of the most common cyclical stock examples include companies representing these industries:
• Travel and tourism, including airlines
• Hotels and hospitality
• Restaurants and food service
• Manufacturing (i.e. vehicles, appliances, furniture, etc.)
• Retail
• Entertainment
• Construction
Generally, consumer cyclical stocks represent “wants” versus “needs” when it comes to how everyday people spend. That’s because when the economy is going strong, consumers may spend more freely on discretionary purchases. When the economy struggles, consumers may begin to cut back on spending in those areas.
Cyclical Stocks vs Noncyclical Stocks
Cyclical stocks are the opposite of non cyclical or defensive stocks. Noncyclical stocks don’t necessarily follow the movements of the market. While economic upturns or downturns can impact them, they may be more insulated against negative impacts, such as steep price drops.
Non Cyclical stocks examples may include companies from these sectors or industries:
• Utilities, such as electric, gas and water
• Consumer staples
• Healthcare
Defensive or non cyclical stocks represent things consumers are likely to spend money on, regardless of whether the economy is up or down. So that includes essential purchases like groceries, personal hygiene items, doctor visits, utility bills, and gas. Real estate investment trusts that invest in rental properties may also fall into this category, as recessions generally don’t diminish demand for housing.
Cyclical stocks may see returns shrink during periods of reduced consumer spending. Defensive stocks, on the other hand, may continue to post the same, stable returns or even experience a temporary increase in returns as consumers focus more of their spending dollars on essential purchases.
Dive deeper: Cyclical vs Non-Cyclical Stocks: Investing Around Economic Cycles
Pros and Cons of Investing in Cyclical Stocks
There are several reasons to consider investing in cyclical stocks, though whether it makes sense to do so depends on your broader investment strategy. Cyclical stocks are often value stocks, rather than growth stocks. Value stocks are undervalued by the market and have the potential for significant appreciation over time. Growth stocks, on the other hand, grow at a rate that outpaces the market average.
If you’re a buy-and-hold investor with a longer time horizon, you may consider value cyclical stocks. But it’s important to consider how comfortable you are with investment risk and riding out market ups and downs to see eventual price appreciation in your investment. When considering cyclical stocks, here are some of the most important advantages and disadvantages to keep in mind.
Recommended: Value Stocks vs. Growth Stocks: Key Differences for Investors
Pros of Cyclical Stocks
• Return potential. When a cyclical stock experiences a boom cycle in the economy, that can lead to higher returns. The more money consumers pour into discretionary purchases, the more cyclical stock prices may rise.
• Predictability. Cyclical stocks often follow market trends, making it easier to forecast how they may react under different economic conditions. This could be helpful in deciding when to buy or sell cyclical stocks in a portfolio.
• Value. Cyclical stocks may be value stocks, which can create long-term opportunities for appreciation. This assumes, of course, that you’re comfortable holding cyclical stocks for longer periods of time.
Cons of Cyclical Stocks
• Volatility. Cyclical stocks are by nature more volatile than defensive stocks. That means they could post greater losses if an unexpected market downturn occurs.
• Difficult to time. While cyclical stocks may establish their own pricing patterns based on market movements, it can still be difficult to determine how long to hold stocks. If you trade cyclical stocks too early or too late in the market cycle, you could risk losing money or missing out on gains.
• Uneven returns. Since cyclical stocks move in tandem with market cycles, your return history may look more like a rollercoaster than a straight line. If you’re looking for more stable returns, defensive stocks could be a better fit.
💡 Quick Tip: Distributing your money across a range of assets — also known as diversification — can be beneficial for long-term investors. When you put your eggs in many baskets, it may be beneficial if a single asset class goes down.
How to Invest in Cyclical Stocks
When considering cyclical stocks, it’s important to do the research before deciding which ones to buy. Having a basic understanding of fundamental analysis and technical analysis can help.
Fundamental analysis means taking a look under a company’s hood, so to speak, to measure its financial health. That can include looking at things like:
• Assets
• Liabilities
• Price to earnings (P/E) ratio
• Earnings per share (EPS)
• Price to earnings growth (PEG)
• Book to value ratio
• Cash flows
Fundamental analysis looks at how financially stable a company is and how likely it is to remain so during a changing economic environment.
Technical analysis, on the other hand, is more concerned with how things like momentum can affect a stock’s prices day to day or even hour to hour. This type of analysis considers how likely a particular trend is to continue.
Considering both can help you decide which cyclical stocks may be beneficial for achieving your short- or long-term investment goals.
The Takeaway
Cyclical stocks are stocks that tend to follow trends in the broader economic cycle, with returns fluctuating as the market moves. Cyclical stocks could be a good addition to your portfolio if you’re interested in value stocks, or you want to diversify with companies that may offer higher returns in a strong economy.
Investing in cyclical stocks does have its pros and cons, however, like investing in just about any other type or subset of securities. Investors should make sure they know the risks, and consider talking to a financial professional before making a decision.
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