Cyclical stocks are stocks of companies whose prices move strongly with the state of the economy. These are usually companies that provide non-essential goods and services. If the economy grows, cyclical stocks typically benefit. If the economy goes into recession, cyclical stocks often fall sharply.
Why do cyclical stocks move with the economy?
Cyclical companies usually sell services and products that can be considered non-essential. These can be luxury products like smartphones and cars, travel industry services or commodities that are in greater demand due to increased production when the economy is doing well.
Examples of non-cyclical stocks include Ahold Delhaize and Unilever. These companies are both in the food sector. Whether the economy is doing well or not, people will always need food. This makes the sales of these companies less sensitive to economic fluctuations.
What stages can we distinguish during an economic cycle?
The economy often moves in a cycle that begins with a period of economic growth and then turns into a recession. Then comes a period of recovery after which the cycle begins again. These are the four stages of the economic cycle:
The cycle begins with a period of economic progress. The economy is running at full throttle, and there is high demand for non-essential products and services. At some point, the economy flattens out, and growth reaches its peak. The economy stagnates. After this period of stagnation, a contraction of the economy takes place. Demand for non-essential products and services declines sharply. A recession is followed by a period of recovery. After this period, the cycle begins again.
There is no set recipe for the course of an economic cycle. For example, a period of stagnation is not necessarily followed by a recession. There can also be another period of economic growth that eventually turns into a recession later on.
Examples of cyclical stocks
Cyclical stocks can be found in the following sectors:
Aviation and travel industries
People usually go on vacation, catch a flight, take a city trip or books hotel when the economy is doing well. In times of economic downturn, we go on vacation less often and spend less money on these types of activities.
Cars are luxury products, and buying a new car is a substantial investment for most people. These products are less likely to be purchased when the economy slows down.
Raw materials and chemicals industry
When the economy is on a downturn, fewer raw materials are needed. This is because the demand for products is lower therefore fewer products are produced that require these raw materials.
Real estate and construction sector
Homes and commercial properties are built, sold and rented more during times when the economy is booming. If a country's financial situation deteriorates, this is often directly reflected in the construction, rental and sales of real estate.
When there is less money in circulation and fewer loans being made, banks and other financial institutions earn less. In turn, the state of the economy affects the financial sector.
Luxury products such as TVs, laptops and other electronics products are sold less when people have less to spend during a recession. Consequently, many chip manufacturers see their sales decline as their chips are incorporated into these devices.
Early- and late-cyclical stocks
With cyclical stocks, we can distinguish between early-cyclical and late-cyclical stocks. An early-cyclical stock reacts almost immediately to a fluctuation in the economic environment. A late-cyclical share reacts later.
Shares of companies that offer/produce luxury products and services such as electronics, vacation trips and cars are classified as early-cyclical shares. You see a decrease or increase in these almost immediately when the economic climate turns.
When the economy is doing well, the construction sector usually flourishes later. Shares of companies in the construction sector can therefore be called late-cyclical shares. Construction plans often have a long run-up as they take a while to get going.
Getting in and out at the right time
Timing is important when buying cyclical stocks because they have a lot of volatility. Getting in at the wrong time can mean buying stocks that are at their highest point in the cycle in terms of price. On the other hand, you can also pick up stocks at a bargain price at the low point of a cycle.
When timing entry and exit points, it is important that you learn about the industry of the stocks you are buying. The better you know the product or service of the company you want to buy, the better you can estimate the right buying or selling moment of a cyclical stock.
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