Quick definitionCopy link to section
Cyclical stocks are shares of a company that fluctuates in price in sync with economic cycles.
Key detailsCopy link to section
- Cyclical stocks move in line with how the economy is fairing. In times of economic growth they will rise and in times of recession they will fall.
- Cyclical stocks are volatile and can generate high returns when the economy is doing well.
- The consumer discretionary sector includes cyclical stocks like Amazon, Tesla, and McDonalds.
What is a cyclical stock?Copy link to section
Cyclical stocks are shares of a company that rises and falls in line with economic cycles. When the economy is performing well, cyclical stocks tend to rise and when it’s performing badly they tend to fall. Cyclical stocks usually fall under the discretionary sector. These are companies selling products or services that are not essential and often the first thing consumers cut during difficult economic periods such as recessions.
When an economy is strong consumers generally have more money to spend on discretionary purchases like travel, hospitality, and automobiles. Companies operating in these areas (and other consumer discretionaries) see profits increase which can be passed on to shareholders through dividends. Cyclical stocks may generate strong growth in a strong economic climate.
The opposite is true for a difficult economy or recession. Consumers have less disposable income and cut back on their discretionary spending. People spend less money on hospitality, travel, and cars (and other discretionaries) resulting in poor cyclical stock performance, lower profits, and dividend cutbacks.
What are the defining characteristics of cyclical stocks?Copy link to section
1) They do well when the economy does wellCopy link to section
A booming economy creates more money for consumers, which drives consumer spending, which leads to bigger profits for retailers, banks, manufacturers, and other economically sensitive companies, which leads to big price gains. In a recession, the inverse happens and cyclical stocks typically perform poorly, which brings us on to the next point.
2) They fare poorly during recessionsCopy link to section
When the economy turns south and consumer spending dries up, cyclical stocks can suffer big price losses. When that happens, cut your positions, or sell entirely. Don’t try and swim against the tide.
3) Cyclical stocks’ products are often luxury itemsCopy link to section
New cars, hotel stays, and new laptops are items that consumers buy in good times. But they’re not necessities, so the makers of those items are at risk during recessions.
Cyclical stock sectorsCopy link to section
Cyclical stocks operate in industries that are more impacted by changes in the economic cycle. Below are a few examples of cyclical sectors.
Consumer discretionaryCopy link to section
The consumer discretionary sector is large and includes a range of other sectors within it. Consumer discretionary stocks are companies that sell products or services that are deemed ‘non essential’ or luxury goods. Car makers like Tesla, tech companies such as Apple, and fitness platform Peloton are all examples of consumer discretionary stocks.
Airline and hospitalityCopy link to section
The airline and hospitality industries are usually some of the hardest hit during economic downturns and benefit strongly when the economy is doing well. Both sectors are examples of non-durable consumer cyclical industries. Examples include Southwest airlines, Hyatt hotels, and Hilton.
Financial servicesCopy link to section
Companies in the financial sector like banks, have some of the strongest correlation with economic cycles. When the economy is strong, people and businesses are more likely to borrow money from banks and when it’s struggling, people and businesses will save rather than borrow. Examples of stocks in this sector include HSBC, Barclays, and JP Morgan.
Pros and cons of cyclical stocksCopy link to section
Cyclical stocks have advantages and disadvantages. Their main advantage is the potential for quick growth, although this only comes when an economy is strong. Their biggest disadvantage is their volatility and tendencies to fall rapidly when a difficult economic cycle like a recession takes hold. Investing in cyclical stocks is not as smooth sailing as defensive stocks, although the returns can be much more impressive if your timing is right.
Where can I learn more?Copy link to section
To learn more about cyclical stocks and the stock market in general you can visit our courses page. Alternatively check out our investing hub for the latest market news and analysis.
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