Understanding Cyclical Stocks

5 mins read
by Angel One
Don’t put all your eggs in one basket is a famous piece of investment advice by Miguel Cervantes that talks about diversification of portfolio and Cyclical stocks should be a part of your portfolio.

What are Cyclical Stocks

Cyclical stocks are those whose prices are influenced by macroeconomic changes. Their price changes according to the cycles of an economy. The cycle of the economy consists of majorly 4 parts and they are expansion, peak, recession, and recovery.

Cyclical stocks are often found in sectors that are sensitive to economic fluctuations, such as consumer discretionary, industrials, materials, and energy. These sectors are directly linked to consumer spending, construction activity, and manufacturing output, all of which tend to increase during periods of economic growth.

Consumer discretionary stocks are companies that produce goods and services that are considered non-essential, such as clothing, entertainment, and travel. These companies tend to do well during economic expansions as consumers have more disposable income to spend on these types of goods and services. However, during economic contractions, consumers tend to cut back on discretionary spending, and these companies may suffer.

Industrials stocks are companies that produce goods used in construction, manufacturing, and infrastructure development. During economic expansions, there tends to be increased construction and manufacturing activity, which benefits these companies. On the other hand, during economic contractions, demand for these goods and services tends to decrease, and these companies may suffer.

Understanding the logic behind Cyclical Stocks

Automobile manufacturers, airlines, furniture dealers, clothing stores, hotels, and restaurants are a few businesses with cyclical stocks. When the economy is strong, individuals have the money to update their homes, buy new cars, go shopping, and take vacations. Whereas when the Economy performs poorly, these luxuries are among the first items customers eliminate. Cyclical Stocks may lose all of their value in a harsh recession, and companies may even go out of business.

Fluctuations in the prices of cyclical stocks along with the economic cycle add an element of predictability for investors. They attempt to buy the stock at a low price during a recession and sell it at the time of peak.

Now that we have understood the meaning of cyclical stocks, let’s understand the Practical use of Cyclical Stocks.

Cyclical stocks are considered more volatile than non-cyclical stocks or defensive stocks. As the name suggests, defensive stocks defend your portfolio even in the weak stages of the economy, whereas cyclical stocks will lose their value. On the other hand, Cyclical Stocks can easily and utterly outperform the defensive stock at the time of a strong economy. Investors looking from a long-term perspective should ideally have a combined portfolio of cyclical stocks and defensive stocks.

Cyclical stocks Vs Non-Cyclical Stocks

As discussed above, Cyclical stocks reflect the business cycle or economic cycle. On the other hand, Non-Cyclical stocks tend to move according to their own factors irrespective of the economic cycle.  

The other name for Non-Cyclical Stocks is Defensive stocks. These stocks are the ones that consumers buy throughout the economic cycles.

Examples of businesses with non-cyclical stocks include those that deal with food, gas, and water, like HUL. Investors can benefit greatly from adding non-cyclical stocks to their portfolios because doing so will help them to protect their portfolios against losses and hedge the risk at the time of economic weakness.

Risk associated with Cyclical stocks

One of the biggest risks associated with investing in cyclical stocks is their sensitivity to economic fluctuations. As the economy goes through its cycles of growth and contraction, the performance of these stocks can be volatile. Additionally, these stocks tend to be more sensitive to changes in interest rates, which can also affect their performance.

Investors looking to invest in cyclical stocks should pay close attention to economic indicators such as GDP, consumer confidence, and manufacturing data. These indicators can give investors a sense of where the economy is in its cycle and which sectors are likely to perform well.

Examples of Non-Cyclical Stocks

To help you understand, these are some of the most well-known non-cyclical industries:

  1. Non-discretionary businesses that sell necessities, often known as essential goods, are typically more resilient. The category also includes pharmacies and food stores in addition to big box retailers like Walmart.
  2. Since consumers continue to pay their electricity and water bills even during the worst recession, utility stocks often exhibit a high degree of defensiveness.
  3. Stocks in the Indian Stock market such as ITC, Dabur, IRCTC, Marico Ltd., etc are Non-Cyclical stocks or Defensive stocks.

Final words

In conclusion, cyclical stocks are an essential part of the stock market and can offer investors opportunities for growth and profitability. However, investors should be aware of the risks associated with investing in these stocks and should conduct thorough research before investing. By paying attention to economic indicators and taking a long-term approach, investors can potentially benefit from investing in cyclical stocks. Now that you have understood the concept of Cyclical stocks, get a few of them in your portfolio by opening Demat account with Angel One and start building wealth.

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