Cyclical Stocks: Definition, Examples, How to Invest

The definition of shares outstanding is almost self-evident. For example, seasons changing each year, or the sun orbiting the planet – both of these things can be described as cyclical. In the same way that four stages of the economic cycle can be defined as cyclical.

In other words, these stocks perform most strongly when the economy as a whole is at its weakest. As always, there are individual exceptions to the general rule. Similarly, fast food brands sometimes record increased sales during economic slowdowns.

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• The travel industry is cyclical as it relies heavily on consumer spending on vacations and travel.
• Investors frequently choose to use exchange-traded funds (ETFs) to gain exposure to cyclical stocks while expanding economic cycles.
• Durable goods companies are involved in the manufacture or distribution of physical goods that have an expected life span of more than three years.
• Add in the stimulus money and pandemic uncertainty … Then add that it’s an election year!

There is no one-size-fits-all approach when investing in cyclical stocks, as economic shifts are hard to predict, but there are some important things to know before investing. One thing is for sure, investing in stocks always involves risk to some degree and can be very volatile, but some types are more unstable and unpredictable than others. Unlike keeping cash in a ascending broadening wedge savings account, stocks can lose and gain value suddenly over a short period, as is the case, especially with cyclical stocks. The automotive industry is cyclical due to several external factors like seasonal changes in demand, third-party production, and interest rates. The demand trend keeps shifting and isn’t stable and depends mainly on consumer purchasing power.

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Features to Look for in Consumer Cyclical Stock

Meanwhile, the defensive stocks could see profits significantly decline. However, these are still good examples of stocks that generally behave either cyclically or defensively. That said, the nature of a recession or downturn can mt4 account have surprising effects on normally defensive holdings. For example, a severe recession can weigh on even the most defensive stocks as investors pivot to even lower-risk investments such as bonds or cash until the dust settles.

• Profits and share prices of cyclical companies tend to follow the ups and downs of the economy; that’s why they are called cyclical.
• Once markets showed signs of a recovery, Tesla’s stock surged disproportionately thanks to pent-up demand and other tailwinds (such as avoidance of public transport under pandemic conditions).
• Volatility profiles based on trailing-three-year calculations of the standard deviation of service investment returns.
• The point is, they’re dependent on discretionary spending — not vital-to-life purchases like food or utilities.
• Real estate is primarily affected by consumer spending power and economic conditions.
• However, they offer greater potential for growth because they tend to outperform the market during periods of economic strength.

During recessions, consumer demand falls as individuals have less disposable income, reducing corporate profits and, therefore, share prices. Cyclical stocks are mostly companies that sell discretionary items that consumers and businesses can afford to buy without hesitation during an economic boom. When the economy is strong, consumers can spend their income without fear for the future as they feel their jobs are secure. But, on the other hand, they will hesitate to spend money on all non-essentials when the economy is struggling.

How to evaluate cyclical stocks?

The common denominator of cyclical companies is that they produce goods and services that are considered non-essential. They may be on the luxury side (high-end retail, entertainment) or the less-glam side (building materials, auto parts). Investing in non-cyclical stocks is a good way to avoid losses when highly-cyclical companies are suffering.

Real estate industry

A decline in the Consumer Confidence Index (CCI) often precedes a decline in consumer spending on discretionary items. Low interest rates may benefit most (non-financial) cyclical stocks, as cheaper borrowing stimulates economic activity and investment. This usually results in a decrease in earnings, with a negative impact on stock prices. Investing in cyclicals is about managing expectations; the prices can rise and fall suddenly as the economic conditions change. For example, cyclical stocks may appear cheap when one cycle ends, and stock prices start to fall.

In a downturn, growth for these companies may be slower than their long-term average, but it will still be an enduring feature. Cyclicals respond more violently time in market vs timing the market than growth stocks to economic changes. They can suffer mammoth losses during severe recessions and can have a hard time surviving until the next boom.

How and When Should You Trade Cyclical Stocks?

If cyclical stocks are part of your trading strategy, this is a good time to learn the value of adapting. This is why cyclical stocks are considered an offensive tactic in investing. You use them strategically in hopes of generating high returns as quickly as possible when the economy is good. Defensive stocks are usually found in sectors that provide for basic needs, such as food and other consumer staples, utilities, healthcare, and discount products. The point is, they’re dependent on discretionary spending — not vital-to-life purchases like food or utilities. Buying things like cars, high-end appliances, cruise and airline tickets, the latest „It“ bag and the newest iPhone becomes less of a priority when hard times loom and people tend to hold onto their money.

The performance of companies in the finance sector, especially consumer banking, is heavily correlated with the health of the broader economies in which they operate. When employment is high and companies are generating returns, individuals and businesses are more likely to borrow money to spend on equipment, projects and expansion. Consumer banks charge interest on this borrowing to generate their own profits. It is a manufacturer of luxury electric cars, which people buy when they expect to drive around, but also when they have plenty of money that they feel comfortable spending. Ultimately, cyclical stock investing is a game of patience, and the range of stocks goes beyond the 5 companies described above.

This includes companies such as Colgate-Palmolive and the Coca-Cola Company. The stock prices of cyclical and noncyclical stocks relate to how the business cycle changes. Cyclical stocks move more dramatically, both up and down, with the cycle. Noncyclical stocks show little movement relative to the cycle of businesses. Noncyclical stocks represent those items and services consumers and businesses can’t do without. When the economy is growing, on the other hand, these stocks tend to lag behind.

When the economy slows – as it did during the pandemic – fewer people book trips using Expedia’s websites. While the economy was expanding in 2021, it seemed to be nearing a cyclical peak in 2022 when the Federal Reserve started raising interest rates to curb inflation. Founded in 1993, The Motley Fool is a financial services company dedicated to making the world smarter, happier, and richer. The Motley Fool reaches millions of people every month through our premium investing solutions, free guidance and market analysis on Fool.com, top-rated podcasts, and non-profit The Motley Fool Foundation.