What are cyclical stocks?
High inflation and elevated prices have taught many of us that many need to budget and decide what we need day-to-day and how to afford those items. Unlike as recently as a couple of years ago, many products and services that fall outside these budgets may be delayed to another day.
Many consumers may not have the disposable income they used to have and discretionary spending is cut back out of necessity.
Cyclical stocks are companies whose stock prices go up and down with the economy.
The impact of these budgetary restrictions means that spending on products and services by consumers in some markets is cut back, reduced or simply avoided.
This would include spending on furniture, expensive clothing, meals out at restaurants, hotel stays, appliances, construction, air travel or new cars, just to name a few. In good times, these markets thrive, but during inflationary periods, these sectors of the economy feel the pinch.
The stocks of these companies are considered to be “cyclical”. Cyclical industry products are in demand when the economy does well, but fall out of favor when times are tough or household budgets are strained. It is easiest to think of products and services that are “needs” versus “wants.” The “wants” category is made up of cyclical industry products and cyclical stocks and the “needs” category would be non-cyclical stocks.
Think of purchases that might be a luxury when the budget is tight and you are probably thinking of a company with a cyclical stock.
Many cyclical stocks are negatively impacted by consumers who find it necessary to reduce discretionary spending during downturns in the economy.
Examples of cyclical stocks
- Ethan Allen
Within the cyclical stock sector, there are companies that produce durable goods, nondurables, and services.
When a retailer like Target branches out into groceries, they straddle both cyclical and non-cyclical sectors.
Some investors believe they can play the stock market and buy cyclical stocks during a market and economic downturns and then profit as the economy recovers. The problem with this strategy is that it requires an accurate assessment of when the economic cycle has bottomed and it can be challenging psychologically to commit funds when that stock’s price may be depressed for an extended time period.
Other investors consider cyclical stocks can be airlines, hotels, and anything tied to travel. Certain types of manufacturing are also affected during recessions as businesses pull back on investment in response to the decline in demand.
What are non-cyclical Stocks?
Non-cyclical stocks tend not to hurt during inflationary times, or economic downturns in the economy, and are often in sectors referred to as “consumer staples” or “defensive stocks.” One sector that does well during an economic downturn is health care. Other sectors include utilities, pharmaceuticals, and household products. Cyclical and defensive stocks are the flip side of the same coin.
Many of these stocks are also considered consumer essential stocks and can include shipping and transportation and insurance company stocks. Another characteristic of the more defensive stocks is that they also tend to pay consistent dividends and have stable earnings, even in challenging economic periods.
Defensive stocks include consumer products companies that sell essential consumer goods ranging from laundry detergent to toilet paper and diapers—companies whose demand isn’t impacted much by the broader economic environment.
Cyclical ETF and non-cyclical ETF
An alternative approach would be to invest in an exchange-traded fund (ETF) that invests in consumer defensive or consumer staples stocks. There are many ETFs in this sector.
The lesson for investors is to have a diversified portfolio that includes both cyclical and non-cyclical stocks so that economic cycle and business cycle and inflationary periods do not inflict too much damage on your portfolio.
At some point in the future, when interest rates have already fallen, then cyclical stocks may reward investors once again.
Brian Baker, “What are cyclical stocks?,” (2022, October 26), Bankrate.com, Investing