What is a Cyclical Stock?
The price of a cyclical stock is affected by macroeconomic or systematic changes in the overall economy. Cyclical stocks are renowned for mirroring the cycles of the economy, which include periods of expansion, peak, recession, and recovery. These stocks primarily involve companies that sell consumer discretionary items—products consumers turn to when the economy is booming and cut back on during economic downturns.
Key Takeaways
- Cyclical stocks are influenced by macroeconomic changes, with returns that rise and fall with economic cycles.
- These stocks typically contrast with defensive stocks.
- Well-known examples of cyclical stocks include companies like Starbucks and Nike, whereas defensive stocks include staples like Campbell Soup.
- Cyclical stocks are usually more volatile but may yield higher returns during economic growth periods.
The Backbone of Cyclical Stocks
Companies featuring cyclical stocks include car manufacturers, airlines, furniture retailers, clothing stores, hotels, and restaurants. When the economy is thriving, consumers are more willing to buy new cars, upgrade their homes, shop extensively, and travel.
These discretionary expenses are the first to go when economic downturns are severe, making cyclical stocks vulnerable to downturns. However, savvy investors should not entirely avoid these stocks but should carefully manage their allocation.
Cyclical stocks rise and fall predictably with economic cycles, encouraging some investors to time the market by purchasing shares during a downturn and selling them as the economy peaks.
Special Considerations for Investors
Cyclical stocks are regarded as more volatile compared to noncyclical or defensive stocks, which maintain stability even during economic challenges. Nonetheless, cyclical stocks possess greater potential for growth as they often outperform the market during economic expansions. Investors seeking long-term growth while managing volatility should balance their portfolios with both cyclical and defensive stocks.
To gain exposure to cyclical stocks during periods of economic growth, investors often opt for exchange-traded funds (ETFs). One popular cyclical ETF investment is the Consumer Discretionary Select Sector Fund (XLY).
Cyclical vs. Noncyclical Stocks
Cyclical stocks’ performance is closely tied to the economy, whereas noncyclical stocks, also known as defensive stocks, often outperform regardless of economic conditions. Defensive stocks include consumer staple goods and services, such as those offered by companies like Walmart, catering to everyday needs.
By adding noncyclical stocks to a portfolio, investors can hedge against risks associated with cyclical stocks during economic downturns.
Exemplary Cyclical Stocks
Cyclical stocks can be categorized into durables, nondurables, and services:
- Durables: These companies manufacture or distribute physical goods with a lifespan exceeding three years, such as Ford (automakers) and Whirlpool (appliance manufacturers).
- Nondurables: Companies producing goods with a lifespan under three years, such as Coca-Cola and Procter & Gamble.
- Services: Businesses that provide leisure, travel, and entertainment services. Notable examples include Walt Disney (DIS) and streaming giants like Netflix (NFLX).
How to Collect Income from Stocks
A stock represents a share of ownership in a company. When a company performs well, stockholders receive dividends as a form of income. Investors can either reinvest these dividends or take them as cash payments. Selling stocks at a profit results in capital gains, contributing further income.
Top Cyclical Stocks to Consider
The best cyclical stocks serve to align with your individual goals and risk tolerance. Popular options include stocks from companies like Costco, Expedia, UPS, Airbnb, and Kohl’s, highly rated by sources such as Yahoo Finance.
Defining Counter-Cyclical Stocks
Contrary to cyclical stocks, counter-cyclical stocks often rise in value when the economy falters. As the economy declines, these stocks tend to flourish, making them valuable for balancing a portfolio.
Conclusion
Cyclical stocks move in sync with economic trends, offering high returns during periods of growth but posing higher risks during downturns. Balancing your portfolio with both cyclical and noncyclical stocks is key to managing their volatility while optimizing potential returns.
Related Terms: Noncyclical Stocks, Defensive Stocks, Economic Expansion, Recession, ETFs.
References
- State Street Global Advisors SPDR. “The Consumer Discretionary Select Sector SPDR Fund”.
- U.S. Bureau of Labor Statistics. “Merchant Wholesalers, Durable Goods: NAICS 423”.
- Uvig.org. “What Companies Are in the Consumer Non-Durables Field?”
- FINRA. “Investment Products Stocks”.
- Yahoo Finance. “14 Best Cyclical Stocks to Invest In”.
- Yahoo Finance. “11 Best Counter Cyclical Stocks to Buy Now”.
