What Are Cyclical Stocks?

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Contributor, Benzinga
October 13, 2023

Stocks rise and fall for many reasons — weak earnings, revenue misses, poor investment sentiment and analyst downgrades. But the timing is not always predictable, making the stock market a level playing field for all investors. 

One group of stocks tends to move in tandem with the business cycle. Cyclical stocks are affected by the cycles of the economy. This article looks at what cyclical stocks are and the types you can choose from, including the benefits and risks of investing in them.

Cyclical Stocks Explained

Cyclical stocks are stocks whose prices are sensitive to economic activity and track the business cycle (expansion, peak, recession and recovery). When the economy is doing well, cyclical stock prices tend to go up. Similarly, when the economy is not doing well, prices of cyclical stocks often go down. 

Cyclical stocks are stocks of companies in discretionary categories like luxury goods, airlines or car manufacturers. Being discretionary means that the product or service is non-essential. Customers tend to spend money on these products or services when they are confident — the economy is doing well — and spend less economic prospects are dimmer — like in a recession. The cyclical pattern of spending affects the earnings of these companies. 

How to Identify Cyclical Stocks

One way to identify a cyclical stock is by looking at its beta value. A beta value or coefficient is a measure of a stock's sensitivity to changes in the market. It is used to indicate a stock's volatility over time compared to the market benchmark. 

A beta of 1 suggests that a stock's volatility matches exactly with the S&P 500, an equity market benchmark. A higher beta indicates greater volatility, and a lower beta indicates less. Cyclical stocks usually have a higher beta coefficient than the S&P 500.

Cyclical vs. Non-cyclical Stocks

Whereas the returns on cyclical stocks are often directly correlated with the economy, non-cyclical stocks are those whose performances are not as dependent on the state of the economy.

Non-cyclical companies produce goods or services that are essential like food, healthcare or utilities. These companies are referred to as consumer staples because their products are generally needed regardless of the state of the economy.  

Non-cyclical stocks are also called defensive stocks because they are generally lower volatility and often resilient against economic downturns — they typically remain profitable in spite of economic downturns. This quality can make them an attractive market segment to invest in during recessions. 

Examples of Cyclical Stocks

Cyclical stocks can be grouped into several categories such as durable vs. non-durable, service and consumer vs. non-consumer. Let's have a look at the various categories and their examples. 

1. Durable and Non-Durable

Durable cyclical stocks are companies that offer physical goods that last for more than three years. These products include tangible items such as machinery or automobiles. Non-durable stocks are companies that produce goods that last for less than three years. These represent items that people consume quickly such as cleaning supplies, clothing or food.

2. Service

Service cyclical stocks are companies that provide services to individuals or corporations. These companies are usually found in the leisure, entertainment or travel sectors. 

3. Consumer and Non-Consumer

Consumer cyclical stocks are companies that cater to individuals or households — housing, entertainment and retail. Non-consumer cyclical stocks are companies that cater to institutions, such as governments and private companies. An example of a non-consumer cyclical company would be a defense contractor.  

Pros of Cyclical Stocks

Several aspects of cyclical stocks can make them appear desirable during recessions.

The Potential to Outperform the Broader Market

Cyclicals generally benefit when economies are experiencing growth and expansion. At times, cyclical stocks can also outperform growth stocks and the market as a whole in periods of growth. 

Undervalued

More volatile and track macroeconomic trends, you may have an opportunity to buy them at lower value during economic downturns.

Diversification

Adding cyclical stocks to your portfolio offers diversification and may help reduce overall risk. Certain cyclical stocks can rise quickly in a healthy economy and potentially offer substantial growth. But it’s not always possible to predict the turn of a cycle, so having cyclicals in your portfolio can help offset the risk of being too conservative, depending on your individual situation. 

Cons of Cyclical Stocks 

Not every quality of cyclical stocks is beneficial.

Dependent on the Economy

Even though economies follow a pattern of rise and fall, timing the cycles can be difficult. As such, it is difficult to know when to trim your position in a cyclical stock and when to hold on to it. Given this, an investor in cyclical stocks may experience losses. 

Higher Volatility

Cyclical stocks tend to have a high beta coefficient, which makes them more volatile than the market benchmark. This could lead to large price swings which may cause huge drawdowns on your overall portfolio.

Market Timing

Cyclical stocks are not a set-it-and-forget-it type of investment. Investing in them means you may have to be constantly tracking the market and economic news as this can affect the prices of many cyclical stocks and how you manage them. You typically can’t be a passive investor with cyclical stocks. 

Investing with the Flow

Cyclical stocks are found in sectors that produce goods and services that are non-essential. Because of the discretionary spending on such products, their performance is heavily tied to the state of the economy. When the economy is doing well, cyclical stocks tend to do well. In the same vein, when the economy is going through a rough patch, cyclical stocks usually do not perform well. 

Investors find that cyclical stocks can be a source of diversification to portfolios because these stocks provide exposure to the economy, balancing against stable or defensive stocks. Just remember that you generally can't afford to be a passive investor with these potentially volatile securities. You have to constantly track economic trends, market forecasts and news.

Frequently Asked Questions

Q

What are examples of cyclical industries?

A

Examples of cyclical industries include manufacturing, retail and airlines.

Q

When to consider cyclical stocks?

A

Investors may want to consider cyclical stocks if they want to add beta to their portfolio i.e. additional risk that’s tied to the economic cycle. However, that cannot be the only reason to consider cyclical stocks.  It’s important to do your research on different factors as well. 

Q

How do you tell if a stock is cyclical or non-cyclical?

A

You can tell if a stock is cyclical or non-cyclical  by its sensitivity to economic cycles. Cyclical stocks are more affected by economic downturns or expansions, whereas non-cyclical stocks are typically more stable.

About Anna Yen

Anna Yen, CFA is an investment writer with over two decades of professional finance and writing experience in roles within JPMorgan and UBS derivatives, asset management, crypto, and Family Money Map. She specializes in writing about investment topics ranging from traditional asset classes and derivatives to alternatives like cryptocurrency and real estate. Her work has been published on sites like Quicken and the crypto exchange Bybit.