Cyclical Stock Definition

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What Is a Cyclical Stock?

A cyclical stock is a type of equity security whose price is affected by
macroeconomic, systematic changes in the overall economy. Cyclical stocks are
known for following the cycles of an economy through expansion, peak,
recession, and recovery.

Cyclical stocks typically refer to companies that sell discretionary items

consumers can afford to buy more of in a booming economy. Alternatively,
cyclical stocks are also companies that consumers choose to spend less with and
cut back on during a recession. Defensive stocks are generally the opposite of
cyclical stocks. They encompass the consumer staples category, with goods and
services that people continue to demand through all types of business cycles,
even economic downturns.

Cyclical Stocks Explained

Cyclical stocks rise and fall with the economic cycle. This seeming predictability
in the movement of these stocks’ prices leads some investors to attempt to time
the market. They buy the shares at a low point in the business cycle and sell them
at a high point. Examples of companies whose stocks are cyclical include car
manufacturers, airlines, furniture retailers, clothing stores, hotels, and
restaurants. When the economy is doing well, people can afford to buy new cars,
upgrade their homes, shop, and travel. When the economy is doing poorly,
these discretionary expenses are some of the first things consumers cut. If
a recession is severe enough, cyclical stocks can become completely worthless,
and companies may go out of business.

Fast Facts
 Cyclical stocks are affected by macroeconomic changes with returns that
follow the cycles of an economy.
 Cyclical stocks are generally the opposite of defensive stocks. Cyclical
stocks include discretionary companies while defensive stocks include
staples.
 Cyclical stocks usually have higher volatility and are expected to produce
higher returns during periods of economic strength.

The Role of Cyclical Stocks in a Portfolio

Cyclical stocks are viewed as more volatile than noncyclical or defensive stocks,
which tend to be more stable during periods of economic weakness. However,
they offer greater potential for growth because they tend to outperform the market
during periods of economic strength. Investors seeking long-term growth with
managed volatility tend to balance their portfolios with a mix of cyclical stocks and
defensive stocks.

Frequently, investors choose to use exchange-traded funds (ETFs) to gain

exposure to cyclical stocks while expanding economic cycles. The SPDR ETF
series offers one of the most popular cyclical ETF investments in the Consumer
Discretionary Select Sector Fund (XLY).

Real World Examples

Cyclical stocks are often further delineated by durables, nondurables, and
services.

Durable goods companies are involved in the manufacture or distribution of

physical goods that have an expected life span of more than three years.
Companies that operate in this segment include automakers such as Ford Motor
Company, appliance manufacturers such as Whirlpool Corporation, and furniture
makers such as Ethan Allen Interiors Inc. The measure of durable goods orders
is an indicator of future economic performance. When durable goods orders are
up in a particular month, it may be an indication of stronger economic activity in
the ensuing months.

Nondurable goods companies produce or distribute soft goods that have an

expected life span of fewer than three years. Examples of companies operating
in this segment are sports apparel manufacturer Nike Inc. and retail stores such
as Nordstrom Inc. and Target Inc.

Services is a separate category of cyclical stocks because these companies do

not manufacture or distribute physical goods. Instead, they provide services that
facilitate travel, entertainment, and other leisure activities for consumers. Walt
Disney Company (DIS) is one of the best-known companies operating in this
space, but it is joined by many companies operating in the new digital area of
streaming media, such as Netflix Inc. and Time Warner Inc.
Counter-Cyclical Stock
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What is Counter-Cyclical Stock?

A counter-cyclical stock is a type of stock in which the underlying company
belongs to an industry or niche with financial performance that is negatively
correlated to the overall state of the economy. As a result, the stock's price will
also tend to move in a direction that is opposite to the general economic trend,
meaning appreciation occurs during times of recession and depreciations in value
occur in times of economic expansion.

BREAKING DOWN Counter-Cyclical Stock

Generally, it is harder to become counter-cyclical stock because it is fairly difficult
to find a business model that thrives in a period where most people do not have
money.

Outplacement agency stocks, for example, would be considered counter-cyclical,

because these companies help laid-off workers find jobs in exchange for a fee.
This type of company would be more successful during times of recession,
because there would be more unemployed workers at that point in time compared
to times of expansion. Purchasing counter-cyclical stocks can serve as a
good hedge to the standard recessionary pressures that can cause most stocks
to decline.

Not as many investors think of counter-cyclical stocks when considering their

investing possibilities. Also, there is always total agreement on which companies
and industries can be classified as counter-cyclical. However, those that get
usually mentioned include alcohol-related companies and discount retailers,
and as desperate times might lead more people to desperate measures, investors
can now invest in the uptick in crime that accompanies a sour economy as many
prisons are now operated by public corporations.

Counter-cyclical industries can suffer greatly during economic expansions (which

can last for years). Such companies may even be prone to bankruptcy if they
don't have the cash on hand or strong balance sheets to weather a long economic
expansion. Investors attracted to stocks in counter-cyclical industries are faced
with the arduous task of trying to time the market--that is, to predict where the
bottom of the business cycle is in order to sell at the optimal time and then predict
where the top of the cycle is in order to buy at the optimal time. This can be hard,
given the fact that some countercyclical stock s start sliding before a recovery
has actually begun.

Risks of Investing in Counter-Cyclical Stocks

Investing heavily in counter-cyclical stocks carries risks that come from
the complexities of the stock market system. If, for example, it appears that the
market is headed for a big recession, there are some potential issues to think
about before immediately reallocating assets into counter-cyclical stocks or other
securities. One potential issue is that market growth is not always proportional to
stock market growth; a tiny market upswing, particularly during a recession, can
lead to an enormous market jump. Because of this, while the whole market may
be falling, certain areas may experience surges, which might cause a counter-
cyclical stocks to under-perform.