All investors strive to have a balanced portfolio for more stability. One of the tools they can employ to achieve this goal is by giving careful consideration to stock selection. While there are many ways to understand which stocks to purchase, one could look at their intrinsic nature to analyse cyclical and non-cyclical stocks.
A good understanding of the difference between cyclical and non-cyclical stocks will equip you to make informed choices and diversify your portfolio efficiently.
But, first, let’s understand what cyclical and non-cyclical stocks are.
The economic climate is never constant due to continual variations in demand and business cycles. A cyclical stock moves in correlation with the general economic climate. Hence, if the market goes up, the stock prices would rise. If the market goes down, so would the prices of these cyclical stocks.
For example, when the economy expands, people tend to purchase more and exhibit increased spending on real estate, automobiles, travel, luxury goods, and more. The industries which offer these products are referred to as cyclical industries.
On the other hand, people conserve spending on essentials like food, medicines, and utilities during a recession. Examples of non-cyclical industries include FMCG, Utilities (like electricity and gas), and Pharmaceutical companies.
Hence, for cyclical stocks, investors would tend to buy these when the market is down and sell in the event of an upward market trend. However, the investor must accurately predict the market trends- both the upswing and downswing to effectively leverage them.
Cyclical v/s Non-Cyclical stocks
Relationship with the market: Cyclical stocks are more aligned with the market’s general mood and condition. In contrast, non-cyclical shares are not aligned with market conditions. These non-cyclical industries are independent of the influence of market boom or slump as they cater to essential needs. The demand for such essential goods remains constant irrespective of market movement, providing immunity in the event of an economic downfall.
Volatility: Cyclical stocks tend to be more volatile than non-cyclical ones as they vary with consumer demand. Due to this variance, cyclical stocks are known as offensive stocks, and non-cyclical shares are called defensive stocks.
Risk element and returns: One would associate cyclical stocks with a higher risk, but also higher return in an upward cycle. If timed well, trading cyclical stocks could lead to significant profits. On the other hand, non-cyclical shares, due to their nature, would offer lower risks and more stability in returns. During an economic downturn, these stocks would also help to avoid losses.
Investing in cyclical stocks requires a knowledge of business cycles. A wise investor can balance cyclical and non-cyclical stocks’ benefits to their advantage by considering the market trends, timing, and direction. A balanced portfolio must include a mix of both these types of shares, chosen based on several factors, including the investor’s risk appetite.
Want more specific information on how you can leverage Cyclical vs Non-cyclical stocks for your portfolio? Contact our experts at Angel One for the right guidance.