Cyclical stocks are shares of companies that are highly sensitive to economic cycles. These stocks show larger swings in response to changes in the current economic climate. A cyclical stock can quickly reflect a market recovery, but is equally an indicator of a downward movement. These stocks fit within a diversified investment portfolio. An active investor can use cyclical stocks to spot major market movements more quickly and respond to the expected direction of the market.
Examples of cyclical stocks
A type of company that falls under the cyclical category is one that is sensitive to economic changes. For instance, companies active in the employment sector are the textbook example of cyclical. When the economy recovers after a period of recession, you typically see employment pick up again. Companies active in recruitment or temporary staffing, for example, will be the first to react strongly to those changes in the economy.
Companies that deal in luxury goods, such as hotels, handbags, or premium beverage brands, will also respond more quickly to a recovery than other stocks. When market conditions improve, people will resume buying luxury goods more quickly, but during downturns, these types of products are the first to be cut from the budget.
Cars or the raw materials used in them are also considered cyclical products. Companies that produce essential goods are not considered cyclical, because these types of products will always be purchased regardless of the economic situation.
Cyclical stocks: who are they for?
Are you an investor who isn't afraid of some volatility in your portfolio? Do you understand stock price movements and are you also looking for opportunities that can make you money when the market drops through short positions? Then stocks in cyclical companies might fit within your portfolio. These stocks do not fall under defensive stocks. They are more recommended for investors with a dynamic profile. Do you understand the economic cycle? Do you know the techniques to speculate in declining markets? Then you can certainly consider investing in shares of cyclical companies.
Many investors don't invest directly in this type of stock. However, they do use the cycle of their price movements as a trend indicator to structure the rest of their portfolio according to financial market expectations.
How to find them?
How do you know what a typical cyclical stock is? These stocks are listed, just like regular stocks, in the standard indices. Of course, you can apply your logical analysis to determine which companies will be the first to react to major economic changes. In addition, there are always indices that track certain types of stocks, such as everything biotech-related, or only consumer goods. These types of indices also exist for cyclical stocks. The contents of these indices are freely available on their providers' websites. Investors who don't want to immediately make a specific selection of stocks can also gain exposure to these indices through, for example, a tracker or thematic funds.
Conclusion: account for volatility
Are you considering an investment in stocks with a cyclical nature? Then be sure to account for the volatility of these stocks. Thanks to their large swings, you can ride the positive waves of an economic recovery, but the tide can turn. For experienced investors, they can even offer opportunities in declining markets, thanks to the short positions that can be taken. Those who understand this type of stock and are willing to accept the risks due to their high volatility can achieve attractive returns.