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What Are Cyclical Stocks?

Sebencapital

Published
19/01/24
What Are Cyclical Stocks?

DEFINITION:

Cyclical stocks are like a ride with the economy. When the economy is doing well, these stocks can make a lot of money, but when it's not, they can also lose a lot.

Key Takeaways

  • Cyclical stocks go up and down in value along with the overall economy.
  • They're also called offensive stocks because investors can use them to make significant profits when the market goes up.
  • It's essential to mix cyclical investments, which depend on the economy, with noncyclical ones that stay stable no matter how the economy is doing.

Definition and Examples of Cyclical Stocks

Cyclical stocks, also called offensive stocks, are like a rollercoaster, going up and down with the market. When people are spending money, these stocks go up. When they're not, the values go down.

Take car companies as an example. When the economy is strong, and people have jobs, they buy more cars. But when things get uncertain, and there are job cuts and more people without jobs, folks might delay buying new cars.

How Cyclical Stocks Work

In good times, businesses grow. They get new equipment, build more, and spend money on research. Companies in areas like selling equipment, construction, real estate, and technology all ride this economic wave. Restaurants and entertainment businesses also benefit because people spend more.

But when the economy isn't doing well, businesses use up their stock, delay growing, and avoid making big purchases. This slowdown hits companies in fields like making and selling steel.

That's why we call these kinds of stocks "cyclical." They're like a strategic move in investing, used to aim for big returns when the economy is doing well.

Cyclical vs. Noncyclical Stocks

Noncyclical stocks, also known as defensive stocks, are based on things people always need, like toothpaste, soap, or essential foods. These stocks do well even when the economy is slow because people keep buying these essential items.

These stocks represent things that people and businesses can't go without. Think of utilities like water, gas, and electricity—they fall into this category. However, when the economy is booming, these stocks may not grow as fast.

Note

When the economy is not doing well, noncyclical stocks become crucial for investors. These are things people always need, like essential goods, and they are seen as a defensive move. This means investors can still make money even when the economy is not doing great.

What It Means for Individual Investors

To do well as an investor, you should have a good mix of strategies that are like playing offense and defense. This means your investment collection should include:

  • A variety of stocks, bonds, and cash in your investments.
  • Having a mix of different-sized companies and industries in your investments.
  • A mix of value and growth stocks

Another strategy you can use is to have a mix of stocks that go up and down with the economy (cyclical) and stocks that stay steady no matter what (noncyclical) in your investment collection. This helps balance out the impact of changes in the business cycle.

When investors feel like the economy is heading into tough times—when stocks that depend on the economy start to drop and the focus shifts to essential items—those stocks that depend on the economy become less valuable.

Note

Cyclical and noncyclical stocks are linked to how the business cycle shifts. Cyclical stocks have bigger ups and downs with the cycle, while noncyclical stocks don't change much in relation to the ups and downs of businesses.

Standard & Poors Sectors

Standard & Poor's (S&P) puts stocks into 11 groups. Two of them, consumer staples and utilities, are noncyclical stocks. The others are cyclical, but they vary in how much they go up and down, making some moderately cyclical and some highly cyclical.

Here is how S&P classifies stocks by sector:

  • Spending on optional items
  • Essential everyday products
  • Power and fuel sources
  • Banking and money-related businesses
  • Medical and healthcare industry
  • Manufacturing and production industries
  • Tech and computer-related industry
  • Products and resources
  • Property and land industry
  • Communication and phone services
  • Essential services like water, gas, and electricity

Note

Investors don't always use the same sector classifications as S&P. If you check another website, you might see a different way of categorizing sectors. But it's a good idea to stick to one system to avoid getting confused, both for yourself and others.

The Bottom Line

It's a good idea to keep an eye on how businesses are doing to understand where things are and where they're headed. If you want a safer approach as an investor, you should have some noncyclical stocks in your collection. These are stocks from companies that often pay dividends regularly, like Colgate-Palmolive and the Coca-Cola Company.

But remember, this safety comes with a cost. While noncyclical stocks are lower risk, they also give you lower returns, and it might take longer to reach your financial goals. However, during tough economic times, having this safety can be comforting, especially for those close to retirement or needing to use their money sooner.

Written by Sauravsingh

Techpreneur and adept trader, Sauravsingh Tomar seamlessly blends the worlds of technology and finance. With rich experience in Forex and Stock markets, he's not only a trading maven but also a pioneer in innovative digital solutions. Beyond charts and code, Sauravsingh is a passionate mentor, guiding many towards financial and technological success. In his downtime, he's often found exploring new places or immersed in a compelling read.

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