When investing in the stock market, overall market conditions can impact which shares you should buy. Find out which stock types are most sensitive to market conditions.
Bull markets tend to push stocks higher across the board, while bear markets tend to have the opposite effect. Finding stock types that move in concert with the market as a whole can prove to be a highly lucrative venture if you’re able to read the market correctly.
There are two types of stocks that are particularly sensitive to overall stock market and economic conditions, making them especially attractive when bought at the right time: cyclical and defensive stocks.
Cyclical stocks are the stocks of companies such as retailers, airlines, and hotel operators. They rely on a strong underlying economy and consumer demand to boost their price performance.
Defensive stocks include businesses in areas such as utilities that people rely on in both good times and bad. That makes them a rare breed of investment that can actually buck the prevailing trend, offering a safe haven as promising investments during downtimes.
II. Why should investors base the stock types they choose on the overall state of the stock market and the economy?
Because there’s strength in numbers. When the majority of investors are bullish on the economy and the stock market, most stocks tend to move higher. This means you can ride that wave with cyclical stocks and most likely produce hefty gains.
When most investors get spooked by the state of the economy and the stock market, they’re going to shy away from economically-sensitive stocks and go against the grain. That means it’s wise to seek defensive investments in the types of products and services that people turn to during times of economic and stock market upheaval.
III. What are the defining characteristics of each different market cap size?
1) Cyclical stocks
Cyclical stocks (also called consumer discretionary stocks) tend to be extremely sensitive to prevailing economic conditions. When a country’s job market is strong and gross domestic product (GDP) is growing robustly, consumers typically have more disposable income. That in turn supercharges consumer spending, leading to people buying more clothes, more cars, and more household items – as well as traveling more frequently.
On the other side, when the economy contracts, people tend to spend less money on luxury items and take fewer holidays. Retailers, along with travel and hospitality-related companies thus represent some of the most economically-sensitive cyclical stocks.
2) Defensive stocks
Think of defensive stocks (also called consumer staples stocks) as representing companies that offer products and services that people always need, no matter how the economy or the stock market is performing. For instance, whether you’re a homeowner or a renter, you need water and electricity in your house or apartment. That makes the companies that offer such services relatively safe, defensive stocks when times are tough.
Another form of defensive stock are those companies that capitalise on investor tendencies during bear markets. For instance, investors often flock to gold when markets enter turbulent periods. As an extension of that hunger for the commodity itself, investors may invest in stocks that specialise in gold mining and other gold-related industries – making them potentially valuable defensive investments in their own right.
IV. Here are some examples
1) Cyclical stock examples
MGM Resorts International (MGM) is one of the largest casino and hospitality companies in the world, with 2019 revenue of nearly $13 billion. Like the rest of its industry peers, MGM’s finances have been hammered by the economic slowdown and global lockdown caused by the COVID-19 pandemic. The good news is that MGM’s stock has more than tripled in the past six months as investors see better days ahead. Despite that recent rebound, MGM’s stock carries a modest price-to-earnings ratio of just over 6-to-1, making it a potential value stock pick as well.
2) Defensive stock examples
Another byproduct of the global economic slowdown and lockdown has been an increased need for dine-at-home options. That’s made Campbell Soup (CPB) a fairly steady investment in 2020. The maker of numerous foods and beverages has seen its stock just about break even so far this year, with much less fluctuation than more volatile growth stocks. Campbell’s 2.9% dividend yield increases the stock’s stability and safe haven nature.
V. How do I find stocks broken down based on market conditions?
Look no further, you can find them right here. We publish lists of top cyclical and defensive stocks on a regular basis right here on Invezz.
Hopefully you’ve learned a lot about how market conditions affect different stock types, and why you should always consider broad market conditions when investing. In our next lesson, we look at how the quality of different stock types can affect your investment outcomes, and what this means for structuring your portfolio.
Sources & references
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