Investing > Cyclical Stocks Explained

Cyclical Stocks Explained

Invest in a high-risk, high-reward asset—and keep your eyes wide open.

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Updated May 13, 2022

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Would you like a crystal ball that tells you whether the economy is good or bad? 🔮

It’s nice to daydream, but unfortunately, it doesn’t exist. One way we can get close however, is by looking at how well cyclical stocks perform. 

In fact, savvy and experienced investors often use cyclical stocks to gauge the strength of the economy and the market phase we’re currently in. Not only that, but cyclical stocks can be great for generating profits—if you’re armed with the proper knowledge. 

In this guide, we’ll explore everything about cyclical stocks—including (importantly) how they work when it comes to different market cycles. We’ll also compare them to non-cyclical stocks, their advantages and disadvantages, and how to invest in cyclical stocks safely.

Ready. Set. Go! 🚀

What you’ll learn
  • What Are Cyclical Stocks?
  • How Market Cycle Phases Impact Stocks?
  • Cyclical vs. Non-Cyclical Stocks
  • Cyclical Industries
  • Non-Cyclical Industries
  • How to Invest in Cyclical Stocks
  • Advantages of Cyclical Stocks
  • Disadvantages of Cyclical Stocks
  • Conclusion
  • Get Started with a Stock Broker

What Are Cyclical Stocks? 📚

Cyclical stocks refer to how closely a company’s share price is related to the fluctuations in the economy. To put it simply, these stocks tend to rise during a booming economy and fall when economic growth slows. However, there are fundamental differences between companies affected explicitly by economic cycles and those affected by broad economic changes.  

How Do Cyclical Stocks Work? 👷‍♂️

Cyclical stocks are typically stocks of companies that sell consumer discretionary items. These are things that people don’t buy every day, like luxury goods, cars, and cruise tickets. Since people only buy these items when the economy is doing well or recovering, they are more sensitive to changes in the economic cycle. 

Because of this, cyclical companies follow the trends in the overall economy from expansion, peak, and recession to recovery. Their stock prices tend to be very volatile since these higher-end consumer discretionary items are the first things consumers cut out when the economy is tough. In a more extended downturn or recession, some of these companies tend to be the first to go out of business. 

While your job as an investor is not to control these economic cycles, you can tailor your investments to changes in the economy. In fact, some investors like to find opportunities in cyclical stocks and adjust their portfolios to match. Be careful, though—it’s tricky to predict how well a cyclical will do, and each recession and economic downturn is usually different

How Market Cycle Phases Impact Stocks 📊

Market cycles, also known as stock market cycles, are a broad term used to describe trends and patterns that emerge during different markets or business environments. Every market goes through the same phases, and when one market cycle ends, the next one begins. It’s important to remember that market cycles can last anywhere from months to decades. 

You might find some securities or asset classes outperform others during a market cycle. It could be because their business models aligned with growth conditions, or it just happened. A good example would be tech stocks like Zoom during the COVID-19 pandemic. Although the pandemic caused many industries to slow down, the tech industry grew exponentially despite being usually cyclical because it fulfilled a unique condition for growth. 

The Four Market Phases Explained 🗃

Every market goes through four market phases spanned across several months or even years. The first phase is accumulation, which happens when the market has bottomed out. At this point, most investors have given up and sold most of their holdings. But since stock prices at this stage are flattened, some savvy investors can pick up profitable stocks at a nice discount

An example of a full market cycle from August 2005 to March 2008.

After the market has stabilized for a while, the markup phase begins. This might be brought on by positive media reports, which inspire many investors to put money in the market again. Because of this, valuations increase beyond historical norms, and logic begins to exit the building. Many investors will jump on the stock market bandwagon during this phase in hopes of striking gold and in fear of missing out.

The third market phase is distribution, where the stock prices are at their peak. The bullish market that began in the previous phase begins to level out here and can stay locked in a trading range that lasts for a few weeks or months. Emotions run amok as investors are hopeful that stock prices remain high and fearful that it’ll be over soon. The end of the distribution stage can be accelerated by extremely adverse geopolitical events or economic news, such as the oil crisis in 1973 and the Gulf War recession in 1990

Towards the end of the distribution stage, investors realize that the market is slowing down and start frantically selling their stocks. This triggers the final market cycle, called the downtrend or markdown. It’s the most painful for those who didn’t get to sell their stocks since their investments would have been way below the value that they paid for. Investors hold on to some hope that the market will recover but would eventually give up and sell whatever they have to reduce their losses. 💸

Cyclical vs. Non-Cyclical Stocks ⚔

As a counterpart to cyclical stocks, non-cyclical stocks are known as stocks that are relatively unaffected by any economic changes. Because they defend against economic slumps, they are considered defensive assets and are great to include in your portfolio as a safety net. 

Non-cyclical stocks tend to be companies that sell or produce essential items that people can’t do without regardless of economic changes, like groceries, hygiene products, and utilities. When the confidence in the economy is low, consumers reserve what money they have for essential goods. That’s why their stock prices increase in the face of incoming recessions while cyclical stocks dip. 📉

It’s not to say that non-cyclical stocks prevail against all odds. Both cyclical and non-cyclical stocks have been known to tank since they rely on consumer behavior and emotions. Before buying any of these stocks, you need to do adequate research and due diligence about the brand image, growth potential, and reputation for making the most informed decision.

The Cyclical Industries 🏢

Cyclical stocks are typically put into three broad categories: durables, nondurables, and services. Durable goods companies manufacture or distribute physical goods with a long life span, like furniture, kitchen appliances, and cars. During the economic downturn, consumers tend to hang on to what they already have for longer and only spend on new durable items in prosperous times. Because of this, watching how durable goods perform on the stock market can be an excellent indicator of economic activity. 

Nondurable goods companies produce or distribute goods with an expected lifespan of fewer than three years, like apparel and smartphones. People tend to spend less on these items during an economic slump, causing the stocks to suffer. However, certain nondurable goods can be considered non-cyclical. 

Services are considered a separate category because they don’t provide physical goods. They facilitate travel, entertainment, and leisure, which are some of the first things that consumers cut during a slow economy. Think about it—would you spend hundreds of dollars buying airline tickets, hotel stays, Disneyland trips, or save your money for an inevitable rainy day when the economy is down? 💵

Here are some examples of cyclical industries: 

  • ☑ Technology: Most tech stocks are cyclical since people tend not to spend money on the latest technologies when they’re worried about putting a roof over their heads. However, there are exceptions to the rule, like Apple’s continued growth despite economic cycles.
  • ☑ Banks: Many consumers struggle to make their mortgages and loans during a recession, which is why banks tend to not do very well during this time. Not only that, but the interest rates and demand for bank products like credit cards are reduced, causing the bank’s profit margins to shrink.
  • ☑ Manufacturing: Manufacturing can be both non-cyclical and cyclical, depending on what they produce. For example, companies that produce essential goods like P&G and Unilever can defend against recession while automobile manufacturers like General Motors and Ford are cyclical.
  • ☑ Restaurants: People tend to eat at home more often during a recession, and restaurant stocks suffer as a result.

Non-Cyclical Industries ⚡️

As we’ve mentioned above, non-cyclical industries involve essential items and services that consumers can’t do without, no matter what economic cycles we’re in. These typically include companies that offer essentials, like toothpaste, food, and shampoo. 

The same goes for utilities. Regardless of how well the economy is doing, you’d still need electricity, water, and gas in your daily life. You’d also need to get medicine or go to the doctor, making healthcare and pharmaceuticals great non-cyclical industries to invest in during an economic downturn. 

How to Invest in Cyclical Stocks 🏗

Cyclical stocks can sometimes fall further than the rest of the market, which is why it’s important to know what you’re doing when you’re trying to invest. 

Pick Your Industry 💰

If you want to invest in cyclical stocks, you should first pick the industry you want to invest in. It should be something that you know and understand very well. The market often overvalues cyclical stocks during an economic boom, which might cause ill-informed investors to put all their eggs in one basket and lose it all. 

The comparison of stock performance across industries from February 2020 to December 2020.

Not only that, but you should be well-versed enough in the industry to recognize the signs of trouble. The structural changes for these stocks can happen very rapidly—it can take a while to bottom out, and there might be false starts along the way. An excellent example of this is the energy sector which led the way through the first few months of 2021, only to falter by mid-year, and picked up again by the end of the year

Identify the Market Cycle 💱

Different industries correspond with the market cycle differently. If you want to buy cyclical stocks, you must time your entry correctly. The best time to buy cyclical stocks is when prices are low so that you can take advantage of the soar that follows. However, you need to keep your finger on the pulse of the market to make sure that you’re not falling for any value traps or false starts. 

Typically, the closer to the beginning of the accumulation phase, the lower the prices will be. That means you can buy stocks with tremendous growth potential for a hefty discount. However, if you buy at the end of the bullish phase or the very beginning of the bearish phase, you risk holding on to a stock that doesn’t perform. 

That said, sometimes it’s difficult to identify market cycles due to world events. Take the COVID-19 pandemic, for example. In May and June 2021, the U.S. seemed like it was ready to enter a prolonged recovery phase thanks to vaccination programs but was hindered by new variants in August and September. 

Fully Use Your Broker 🎛

Since it’s impossible to predict when everything will happen accurately, the safest way to ensure you don’t overpay for anything is through dollar-cost averaging. You can set up automatic CDA with a good online broker. To avoid paying more than necessary, you can get a cheaper broker or even a robo-advisor. 🤖

Your broker might come from unexpected sources, so make sure that you have all the research tools and data you need. You can also opt for one of leading stock brokerages to ensure that you get timely news and access to all possible markets. Some brokers offer fractional shares, which come in very handy if you don’t have the thousands of dollars you need for a big-named cyclical stock. 

Have a Good Backup Plan 🔒

All cyclical stocks are prone to volatility, which is why you should always devote part of your portfolio to defensive assets. For example, non-cyclical stocks, ETFs, and mutual funds are a great way to hedge against price fluctuations and economic cycles. If what you’re invested in is taking a long downward turn, you’d at least be able to protect the rest of your portfolio. 

Manage Your Expectations 💬

Most investors, if not all, want their holdings to continue to rise no matter what. But, cyclical stocks will always grow and fall in response to the economic cycle. They’ll eventually tank, which causes some feelings of panic and fear in more conservative investors.

A good approach to take when managing your expectations with this stock type is to consider the growth of individual companies by themselves instead of the industry as a whole. There could be a lot of reasons why a company isn’t successful despite being in a thriving industry, so if you’re holding on based only on how the industry is performing, you could fall into a value trap that might cost you more in the long run. 

Buy ETFs 📜

You can invest in cyclical ETFs through a reputable ETF broker to simplify diversification and mitigate some risks of owning stocks through different economic cycles. ETFs also allow you to own fractions of big-named individual cyclical stocks if you can’t afford the high prices of premium cyclical stocks like Amazon. 

Advantages of Cyclical Stocks 🌟

The main advantage of cyclical stocks is, of course, the high returns. Since the demand of cyclical stocks increases dramatically when consumer confidence is high, you’ll be looking at astronomical gains with the right timing. 

Conservative investors often balk at the risk of losing their capital with cyclical stocks. But, in reality, you might end up winning more since recessions only happen every decade or so. With proper research and timing, you can maximize your profits while minimizing the risk at the same time. ⏰

Besides that, cyclical stocks are also relatively straightforward to identify. For example, if you see luxury apparel or car brands, you’d know immediately that they’re cyclical stocks. Despite their volatile nature, investors with a higher appetite for profits can spot cyclical stocks straight away and find opportunities in them. 

A lot of intuition and thought goes into predicting market behavior when investing in the stock market. It’s especially true with cyclicals since you need to really know the economy and industry to get the most profits. That said, cyclicals are a good indicator of investor confidence and the economy’s strength, so savvy investors may use cyclical stocks as a benchmark to adjust their investment strategy.  

Disadvantages of Cyclical Stocks 🚧

With high returns come high risks, and you won’t be able to avoid this with cyclical stocks. Since it depends on market cycles and consumer confidence, they are prone to severe fluctuation, creating more losses for careless investors.

However, the most significant danger about cyclical stocks is that it encourages reckless investing behaviors like market timing. All investors want to buy low and sell high, but there’s no telling what a stock will do from one day to the other. No matter how much homework you’ve done, you won’t be able to know for sure what your profit margin is. 

That said, proper research and technical analysis are prerequisites when investing in cyclical stocks. That could mean extra time spent on research that might lead to you losing the optimal time of entry and exit. However, it’s very easy to panic sell without proper knowledge, so this might become a catch-22 situation for indecisive investors.  

Generally, cyclical stocks are not suitable for long-term investors since they involve active monitoring. You can’t just “buy right and sit tight” with cyclicals—you need to constantly monitor them and react if it goes south. Otherwise, you might find yourself holding on to cyclical stocks that cause significant losses to your portfolio when the economy slows down. 

Conclusion 🏁

Cyclical stocks are affected by economic changes and business cycles. Consumers tend to buy more luxury and discretionary consumer goods during a booming economy, causing cyclicals to skyrocket on the graph. Because of this, aggressive investors love to book maximum profits with this stock type by timing the market. 

There are safer ways to invest in cyclical stocks, like doing adequate research, knowing your industry, and having a good entry/exit strategy. You could also combine cyclical stocks with defensive assets to prevent your entire portfolio from being wiped out by a single trade. Because of its volatile nature, this stock type is unsuitable for passive and long-term investors. 

How Cyclical Stocks Work: FAQs

  • Are Cyclical Stocks Risky?

    Yes, although all stock investments come with some degree of risk, cyclical stocks can be extra volatile since they tend to follow what the economy is doing. When economic data is mixed, they may move up and down a lot in a very short period. Not only that, but timing is a huge factor in whether you'd be successful with cyclical stock, making it extremely risky for new or reckless investors. 

  • Is There an ETF for Cyclical Stocks?

    Yes. There are ETFs specifically designed to invest in the equity of companies that provide nonessential goods and services. These ETFs are also great for investors with a lower risk tolerance since it's already diversified, which cushions their losses in a recession. 

  • Is Amazon a Cyclical Stock?

    Yes. In its nature as a tech company, Amazon is a cyclical stock. Even though the tech giant also sells essential household products, most consumers still prefer to shop at brick-and-mortar retailers because of the immediacy and discounts. 

    However, you have to consider special circumstances and recessions like the COVID-19 pandemic as well. During this time, many people had to shop through a computer, which boosted its stock price even though tech stocks typically tank during recessions. 

  • Is Walmart a Cyclical Stock?

    No. Walmart sells essential goods like food and household products, making it a bonafide non-cyclical stock. Not only that, but you’d also find more sales and discounts during tough times, which attracts more shoppers and defends its share prices. 

  • What Are Consumer Non-Cyclical Stocks?

    Consumer non-cyclical stocks are companies that manufacture or provide essential goods and services that people can’t live without. Retail companies like Walmart, utility providers, and pharmaceuticals are good examples of consumer non-cyclical stocks. 

  • What to Consider Before Investing in Non-Cyclical Stocks?

    Even though non-cyclical stocks fare very well against an economic downturn, you’d need to do sufficient research before going into it. Some of the factors you should consider are growth potential, competitive edge, and consumers’ trust. 

  • Is Real Estate Non-Cyclical?

    Real estate is considered defensive and non-cyclical. However, how well this asset type defends against recession and poor economy depends on the type of properties that the REIT invests in. Companies that hold office properties and hospitals tend to perform better in difficult economies than those that invest in hotels or resorts. 

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All reviews, research, news and assessments of any kind on The Tokenist are compiled using a strict editorial review process by our editorial team. Neither our writers nor our editors receive direct compensation of any kind to publish information on tokenist.com. Our company, Tokenist Media LLC, is community supported and may receive a small commission when you purchase products or services through links on our website. Click here for a full list of our partners and an in-depth explanation on how we get paid.

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