If you’re thinking of dipping your toe into the stock market and have started doing some research, you may have come across the term “cyclical stock”. If you’re not quite sure what it means, and whether it’s a good or a bad thing, here’s what you need to know.
Cyclical stocks are stocks whose performance is affected by macroeconomic factors. When a country is doing well economically, cyclical stocks tend to perform better. In times of economic downturn or uncertainty, cyclical stocks perform less well.
This is often a reflection of consumer confidence. Consumers tend to spend more when their finances are more stable, as is more likely to be the case in a strong economic climate.
Macroeconomic factors that can affect cyclical stocks include political upheaval, war, and major health events such as the coronavirus pandemic. Some of these factors may affect all stock market sectors equally, while others may affect some sectors more than others.
By their nature, cyclical stocks tend to be relatively volatile compared with their counterparts.
Non-cyclical stocks are also known as “defensive” stocks. They’re stocks that tend to perform fairly consistently, and provide stable returns regardless of the economic climate.
Investment experts might make use of certain indicators to assess a stock’s volatility, such as the variability in its earnings per share, or its beta value. A beta value of greater than 1 means that a stock is relatively volatile compared with the rest of the market, indicating it is more likely to be a cyclical stock.
More simply, it can help to think of cyclical stocks as stocks in companies that supply products and services that we can live without. Things that we choose whether or not to spend money on, rather than things that we rely on to live our lives.
Money that we spend on “cyclical” products and services is often referred to as “discretionary” rather than “essential” spending.
In the table below, we’ve highlighted some stock market categories that would typically be regarded as “cyclical”, as well as some that would usually be seen as “defensive”.
| Cyclical stocks | Defensive stocks |
|---|---|
| Cars | Energy |
| Fashion | Food and drink |
| Tech | Healthcare |
| Travel | Utilities |
There will, of course, be grey areas where some stocks in a category are cyclical and others are defensive. Property is a good example. Investments in residential property might be regarded as more cyclical, as people are less likely to move house in a downturn. On the the other hand, investments in essential property, such as medical buildings or supermarkets, might be less cyclical in nature.
Just as a country’s economy doesn’t flip from strong to weak overnight, the performance of cyclical stocks won’t typically yo-yo from stellar to sub-par in a matter of hours or days. Not as a result of macroeconomic factors, anyhow.
An economy’s cycle may follow the stages below as it ebbs and flows. The performance of cyclical stocks will tend to mirror these stages.
In an ideal world, you’d buy cyclical stocks at the start of a period of recovery, while they’re still relatively cheap. They’d then go through their growth period, you’d sell just before a contraction period, and be quids in.
In reality things rarely work out like this, and even experts struggle to time the market in this way. There are no fixed time periods for each stage, and the order of stages is not guaranteed. For example, a “peak” may be followed by another period of expansion, before a subsequent contraction.
So, your best bet is to build a balanced investment portfolio with the right mix of assets to mitigate the risks posed by holding some cyclical stocks. And, in most cases, to stay invested for the long term so you can hopefully ride out the impact of any economic downturns.
Indeed you can. What would be the point of any form of investing if it wasn’t possible – likely, even – that you would make a profit. That’s just as true of cyclical stocks as any other sort of stock.
Of course, there’s also the risk that you could make a loss. That’s also not unique to cyclical stocks.
What is worth bearing in mind, though, is that their cyclical stocks are more volatile by nature than defensive stocks. On the plus side, this means they have a greater chance of high performance in times of economic growth. But it also makes them inherently riskier in an economic downturn. And, as a whole, stocks tend to be riskier than other forms of investing, such as bonds or funds.
If you want your investments to be recession-proof, you may prefer cyclical stocks to form a relatively small part of your portfolio.
The main advantage that cyclical stocks have over defensive stocks is their potential for strong and rapid growth. If you time your purchase right, buying at the start of a growth period and selling before a decline, you could reap big rewards.
Inevitably, the potential for high reward comes with higher risk. While careful monitoring and analysis of the markets can go some way to predicting likely movements in cyclical stock values, even investments gurus often struggle to time the markets perfectly. For those of us who don’t do it for a living, the chances of getting it bang-on are slim.
This means that you have a greater chance of losing money with cyclical than defensive stocks, particularly over shorter investment timeframes.
It’s no more or less easy to invest in cyclical stocks than any other type of stock. It’s just a case of identifying the stocks you’re interested in buying, finding a stock broker or share dealing platform that offers access to them, and making your purchase.
Some cyclical stocks may individually have a quite high value, making investing in them an expensive business. For example, a single share in Microsoft or Tesla would set you back well over US$200, as of July 2023. If this is the case and you don’t have much cash to invest, look out for a provider that offers fractional shares. These let you buy partial shares, making it more affordable for small investors to get exposure to some big-name companies.
To invest in cyclical stocks, follow the steps below:
The vast majority of UK investment platforms and brokers will allow you to trade cyclical stocks available on the London Stock Exchange.
If you want to buy international stocks, make sure that your chosen share dealing platform offers access to relevant foreign stock markets.
We’d love it if there was an easy answer to this. If there was, we’d all be wealthy. In reality, the “best” cyclical stocks for you to buy depends on a huge number of factors.
One of them is, of course, when you’re looking to buy. The best-performing cyclical stock one day may not be the best the next day. And nobody can predict that for certain in advance.
Plus, what counts as the “best” depends on your personal circumstances, goals and investment strategy. Some investors may think that the best cyclical stocks are those which offer the potential for the highest profits, and are willing to accept the higher risk this poses. Others may accept less spectacular returns in exchange for less uncertainty.
To give you some inspiration, we’ve compiled the top trending stocks from leading investment platforms to see which stocks people are buying today. These include a mix of cyclical and non-cyclical stocks.
ETFs (exchange traded funds) are effectively collections of assets, often based around a theme. You can buy and sell ETFs on on stock exchanges in the same way as shares. They can be a good option for beginner investors, or those looking to spread their risk, as they offer exposure to multiple assets in one fell swoop.
While you won’t necessarily find an ETF with “cyclical” in the title, a good option if you want an ETF with a cyclical stock focus is to look out for ones that cover the “consumer discretionary” sector. These will tend to focus on companies where consumer spending is heavily influenced by their confidence in the economy – aka cyclical stocks.
As you may have sussed out by now, we’re not in the habit of giving black and white answers to this kind of question. Whether you should invest in cyclical stocks is a personal decision. Your choice should be informed by a clear investment strategy, thorough research and analysis and, in some cases, discussion with a regulated financial adviser.
But the growth potential of cyclical stocks is strong. So what we can say is that, depending on your goals and risk preferences, they are certainly worth considering as part of a balanced investment portfolio. You can mitigate the higher risk they pose by also including a good mix of lower-risk assets, such as defensive stocks, funds and bonds.
The performance of cyclical stocks is typically closely aligned with the state of the economy. In strong economic climates, cyclical stocks tend to perform strongly. But during a recession, they can suffer and you risk losing money. Despite their volatility, their potential for growth means that cyclical stocks often have a place in an investment portfolio. Smart investors can balance off the risk by holding a mix of cyclical and defensive stocks, and potentially a range of other assets too.
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