What Are Cyclical Stocks?
A cyclical stock is one whose performance is affected by that of the overall economy, following the 4 stages of the economic cycles. But what are the 4 stages of the economic cycle? What are examples of cyclical stocks? In this article, we will provide answers to these questions, telling you all you need to know about cyclical stocks!
Table of Contents
What Are Cyclical Stocks?
Cyclical stocks are the shares of companies whose prospects follow the stages of the economic cycle.
|Expansion: A period of economic growth|
|Peak: Slowing growth|
|Recession: Economic contraction, or decline|
|Recovery: The economy halts its decline and begins to recover|
Cyclical shares invariably operate in industries which flourish during times of economic growth. The profits of cyclical stocks rise in tandem with the economy and come under pressure during a contraction, with the company’s share price taken along for the ride.
Cyclical stocks tend to be shares in companies which produce consumer discretionary goods and services or, in other words, non-essential goods and services. When the economy is growing, consumer spending on these goods tends to increase; whilst, on the other hand, when the economy begins to contract, these types of goods are usually the first to be trimmed from a budget.
Cyclical stocks can be contrasted with stocks which tend to perform consistently regardless of the health of the overall economy, which we will look at in more detail later.
What Are Cyclical Stock Sectors?
It is probably easiest to understand the meaning of cyclical stocks by looking at the sectors within which they tend to operate.
- Travel Stocks: Businesses which operate in the travel industry - such as airlines, cruise line operators and hotels – tend to perform better during times of economic expansion. Most people regard a holiday as somewhat of a luxury, so it stands to reason that during a recession, sales for companies operating in this industry will fall.
- Hospitality: When there is a downturn in the economy, people are less inclined to spend money going out to eat and drink, meaning that shares in restaurants, bars and other hospitality venues tend to suffer.
- Bank Stocks: Banks are cyclical businesses. During periods of economic growth, people spend more and, therefore, borrow more from banks to do so, with credit cards for example. On the other hand, when there is a recession, the opposite is true.
- Automobile Manufacturers: An automobile is a prime example of a purchase which is very likely to be delayed during an economic downturn, with consumers preferring to continue with their current vehicle.
- Technology Stocks: Again, as with automobiles, many new technology purchases – such as computers, mobile phones and games consoles – are likely to be forgone in times of economic hardship. However, it is important to note that not all technology stocks are cyclical.
- Mining Stocks: When the global economy is growing, people demand more of everything, meaning that more raw materials are required for production. In these circumstances, miners of metals such as copper and iron ore tend to perform well.
When it comes to cyclical shares, it is important to understand that not all economic downturns are exactly the same. Therefore, just because a stock is traditionally defined as cyclical, it may react differently to a recession depending on the exact circumstances.
A good and recent example of this is the economic downturn caused by the coronavirus pandemic in 2020. Whilst many traditionally cyclical stocks - such as banks - suffered, numerous tech stocks - such as Apple - performed excellently, as consumers sought new technology to ease lockdown boredom and to equip themselves to work remotely.
Cyclical Stocks Examples
So, now we have an answer to the questions ‘what are cyclical stocks’ and ‘what are cyclical stock sectors’ – what are some cyclical stock examples? Below are some examples, most of which you will have likely heard of, but perhaps not thought of them in such terms:
- American Express
- American Airlines
UK Cyclical Stocks
And what are some UK cyclical stocks examples?
- J D Wetherspoon
- Lloyds Bank
- Rio Tinto
Non-Cyclical Stocks Examples
We already noted that cyclical stocks can be contrasted with stocks which perform well regardless the wider economic climate. Such stocks can be referred to as non-cyclical, however, are more commonly known as defensive stocks.
Non-cyclical stocks typically produce goods and services which are considered consumer staples or, in other words, essential. These non-cyclical stocks operate in so-called defensive industries such as utilities and healthcare.
Some typical examples of non-cyclical stocks include:
- Proctor & Gamble
- NextEra Energy
Top Cyclical Stocks for 2022
So, are there any examples of cyclical stocks which could be poised for a successful year in 2022?
The outlook for 2022 remains somewhat unclear, with conflict flaring up in eastern Europe and rampant inflation worldwide, there are many who feel we may be in store for an economic downturn in the near future.
However, looking at the state of the global economy, we can highlight cyclical stocks that may perform well in 2022.
With inflation on the rise, interest rates are forecast to rise several times this year in many countries. In fact - in the UK, as of April 2022 - the Bank of England has already hiked their base rate three times since December 2021.
Although an economic downturn would see a decrease in new lending for UK banks and an increase in bad debt, the upward trend in interest rates represents a potential positive for banks, who have been operating at record low interest rates for years. In a moderate downturn, higher interest rates will allow UK banks to boost revenue generated by lending as well as lead to an increase in client deposits.
Therefore, UK bank stocks could be an example of cyclical stocks to consider in 2022.
Now that you understand the meaning of cyclical stocks and have some examples, you may be wondering why anyone would add stocks to their portfolio that are likely fall in value if there is an economic downturn. Why not focus solely on non-cyclical, defensive stocks?
Perhaps there are some more risk conscious investors that do opt for this approach, picking investments which solely operate in defensive industries, and which are not prone to fluctuate along with the whims of the overall market.
However, the reality is that the best portfolios are usually made up of a combination of both cyclical and non-cyclical stocks. Diversification is one of the most important qualities of a successful portfolio and, whilst investors may want to treat cyclical stocks with increased caution, it may be wrong to avoid them altogether.
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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.