What is a Cyclical Stock?

A cyclical stock is when the stock price is influenced by macroeconomic or systematic changes in the economy. Cyclical stocks essentially follow the cycles of an economy – expansion, rebound, recession, and recovery. Most cyclical stocks are shares of companies that sell consumer staples. These are items that consumers purchase more during a booming economy but spend less on, during a recession.

Treading the stock market can be tricky. Some stocks are highly vulnerable to economic downturns and slowdowns, while others may be profitable in any economic circumstances, making them relatively recession-proof. Economic activities fluctuate continuously through times of boom and bust, otherwise known as the concept of cyclicality.

The cyclical impact of the Covid-19 pandemic on the stock market is common knowledge. Economically sensitive stocks witnessed a decline through the initial economic downturn. The shares of most companies saw a subsequent rebound as the economy began to recover. Additionally, government stimulus programs and low-interest rates assisted this upturn. This article highlights the meaning of cyclical stocks.

Cyclical stocks examples:

Cyclical stocks are often further described as durable and non-durable goods and services. Durable goods companies are engaged in the production or distribution of physical goods that have an expected useful life of at least three years. Non-durable cyclical stocks either have shorter useful lives, are perishable, or are consumed quickly, such as clothing and prepared foods.

An example of a company that operates in this segment is sports apparel manufacturer Nike. Cyclical services are provided by companies that facilitate travel, entertainment, and other leisure activities for their consumers. Netflix is one of the best-known companies operating in this space.

Popular cyclical stocks in India involve companies like automakers such as Maruti Suzuki India and Tata Motors and banks such as HDFC Ltd. To give you a brief idea of some industries that are prone to cyclicality, we highlight some prominent and easy-to-understand examples:

• Airlines and Hotels: During strong economies, both individuals and businesses tend to be more willing and able to spend money on airline tickets and hotels, than during stringent times.
• Retail: People tend to spend less on discretionary retail goods through durations of economic contraction. However, retailers primarily selling essential goods are not so cyclical.
• Restaurants: In poor economies, people eat at home more often, and F&B stocks often suffer as a result.
• Automakers: Consumers tend to keep their vehicles for longer during recessions and are more likely to buy new vehicles during times of prosperity.
• Technology: Most tech stocks are cyclical.
• Banks: Recessions reduce demand for banking products, including mortgages, auto loans, and credit cards, and more consumers who already have loans struggle to pay their debts. Additionally, interest rates tend to witness a decline before and during recessions, causing bank profit margins to contract.
• Manufacturing: Companies that manufacture physical goods tend to experience plunging demand in times of economic adversity.

Many of the industries mentioned above, such as automotive and retail, are consumer-facing and therefore part of the consumer cyclical stock India sector.

Different cycles and their stocks

Predicting cyclical stock price movements requires a thorough understanding of the business cycle. In times of economic boom, you may observe optimistic spending and investment behavior. With considerably higher per capita incomes, individuals tend to spend more on luxury and convenience items, increasing the profitability of companies that make such items.

This category mainly includes utilities such as televisions, refrigerators, air conditioners, automobiles, etc. In times of economic expansion, companies that manufacture the above items experience the highest growth rates in terms of profitability due to increased market demand. The higher profitability of these companies, combined with a higher demand for the corresponding shares, increases the average price of the share in the market, which in turn increases their profitability even more due to the increase in cash flow.

However, cyclical public companies are the most affected in times of economic recession. The recession is characterized by an economic slowdown, which affects the level of production and employment. As unemployment rises, the demand for consumer goods initially falls, leading to a drastic decline in total income and the consequent profit levels. The share prices of most cyclical stocks collapse in a dire economic scenario due to the lower production volumes of these companies, as well as the lower demand for shares in the trading market.

Business cycle fluctuations and cyclical stock performance are therefore directly related. Since an upward movement in economic output increases the profitability of the issuing companies, while a downward trend in the economic cycle leads to a sharp decline in the profits generated by these companies

The difference between cyclical stocks and non-cyclical stocks

The performance of cyclical stocks tends to correlate with the economy. But that doesn't apply to non-cyclical stocks. These stocks tend to beat the market regardless of economic developments, or even when the economy slows.

Non-cyclical stocks are also called defensive stocks. They encompass the category of consumer staple goods and services that people continue to buy through all kinds of business cycles, even during economic downturns.

Food, gas, and water companies are examples of non-cyclical companies. Adding non-cyclical stocks to your portfolio can be a great strategy for investors, as it helps protect against losses from cyclical companies during an economic downturn.

Non-cyclical stocks examples:

Here are some of the most popular non-cyclical industries for better understanding:

• Non-discretionary retailers that sell things that people need or otherwise known as essential goods, tend to be more resilient. In addition to large retailers like Walmart, drug stores and grocery stores also fall into this category.
• Utility stocks tend to be very defensive as consumers continue to pay their electricity and water bills even during the deepest recession.
• The real estate sector is another sector that is considered defensive, although the degree of deference of action is based on the nature of the characteristics of the company.

Final word

Individuals who choose to invest in companies that issue cyclical stocks should analyze current economic trends and expected investment returns to maximize profit. You must also consider the risk factor to ensure that individuals are not financially affected by stock market fluctuations.