Introduction to Cyclical Stock
The price of a stock affected in the economy due to systematic or macroeconomic changes is known as cyclical stock. This kind of stock follows the economic cycle through recovery, expansion, recession, and peak. The cyclical stock includes companies selling discretionary items to the customers they buy only when there is a growing economy rather than a recession.
Understanding Cyclical Stocks
Companies that deal with cyclical stocks include airlines, car manufactures, clothing stores, restaurants, furniture retailers and hotels. When the economic strength is good, people afford all the luxuries, including shopping, buying a new car, travelling, and even renovating their homes. But these luxuries or discretionary expenses are the first things that we cut off when a recession occurs. During a recession, these companies may even lose their worth and go out of business. Therefore, investors dealing with cyclical stocks must be very careful about their role and never avoid it.
With the change in the economic cycle, there is a rise and fall in the cyclical stocks. Due to this up and down movement in the prices of these stocks, the investors have to time their attempt in the market. This means that the shares should be bought when there is a low point in the economic cycle and sell the same when the economy reaches a high point. Therefore, investors in their portfolios must be very careful about the volume of these stocks. But it also doesn’t mean that investors should keep these stocks away completely.
The defensive stocks, also known as the noncyclical stocks, appear to be more stable when there is economic weakness. But when it comes to cyclical stocks, they tend to show greater stability during times of economic strength. The cyclical stocks are also very volatile. The investors who seek stable growth in the long run with a managed volatility opt for a mixture of defensive stocks and cyclical stocks to make a balanced portfolio.
· The returns of cyclical stocks follow the economic cycle, and these kinds of stocks are affected by systematic or macroeconomic changes.
· Defensive stocks and cyclical stocks are two different concepts. Cyclical stocks involve companies such as Nike or Starbucks, which sells discretionary products. On the other hand, companies under defensive stocks include Campbell Soup.
· Cyclical stocks usually offer greater returns and are highly volatile, especially when we see steady growth in the economy.
Investors generally select ETFs or exchange-traded funds to get more exposure in dealing with cyclical stocks in a booming economic cycle. One of the cyclical ETF investments that are quite popular is the SPDR ETF series in the sector of Consumer Discretionary Select Sector Fund (XLY).
Cyclical vs Noncyclical Stocks
Cyclical stocks performance go in tandem with the economy, which is not the case with noncyclical stocks. Even if the economy is going through a downtrend or a slowdown, the noncyclical ones perform against the odds regardless of what is happening in the economy. These stocks are also known as defensive stocks, including the consumer staples category (generally goods and services). People buy these items even when there is an economic downturn through all the phases of the business cycles. Companies that sell items such as gas, water, and food have noncyclical stocks, and one prime example is Walmart. One should have noncyclical stocks in the portfolio as it protects the investors from losses that cyclical companies can make when there is an economic slowdown.
Example of Cyclical Stocks
Nondurables, durables and services further portray cyclical stocks. Companies that manufacture or distribute physical goods with a life span greater than three years are called durable goods companies. Several companies lie in this category which consists of appliance manufacturers such as Whirlpool, furniture makers like Ethan Allen and automakers like Ford. A good indicator of economic performance is the count or estimate of the orders of durable goods. So if you see that the orders of the durable goods orders are higher at a particular time, then that shows economic activity will be quite robust for the upcoming months.
The companies that distribute or produce soft goods having a life span lesser than three years are known as nondurable goods companies. Several examples of such companies fall in this segment, such as retail stores like Target and Nordstrom and sports apparel manufacturers like Nike.
There is another segment of cyclical stocks which do not distribute or manufacture physical goods known as services. Services supporting travel, entertainment and several other recreation activities fall in this category. One of the prime examples of this category is Walt Disney. Netflix is another best-known company to fall in this segment which primarily streams media in this new digital media space.