Cyclical stocks tend to move with the economic cycle and can be quite volatile in nature.
What Is a Cyclical Stock?
A cyclical stock is one whose price is impacted by economic cycles such as expansion, peak, recession and recovery. Its price, and often the underlying results of the company, are impacted by the various stages of the economic and business cycle.
Cyclical stocks tend to rise and fall based upon changes in the economic cycle. Often the reaction to changes in certain economic factors is quite predictable and savvy investors will buy or sell cyclical stocks based on their estimate of changes in these economic factors.
Airline stocks are a good example of a group whose stocks would be considered to be cyclical. When the economy is doing well and there is low unemployment, travel will likely be up. Businesses can afford for their employees to travel on business. Personal travel will likely be up as well, since consumers will have the money to spend on travel.
Other groups of stocks that tend to do well when the economy is doing well include:
- Furniture retailers. People have money to spend on new furniture and people are more apt to be buying new homes in a good economic environment.
- Car manufacturers and retailers. More vehicles tend to be leased or purchased by both consumers and businesses in a good economy. When the economy slows and business is a bit tougher, people might be inclined to hang onto their cars a bit longer.
- Hotels and resorts. On the same order as airlines, travel will be up, travelers need a place to stay.
Expenditures on these and other types of goods and services that are "nice to haves" vs. day-to-day necessities are considered to be discretionary.
The stocks of these cyclical companies can be high-flyers when the economy is doing well, unemployment is low, and businesses are generally profitable.
However, when economic conditions change, these types of stocks can fall hard. Especially those companies offering luxury products or services. For example, people may still need to travel for business or personal reasons, but if money is a bit tight, they may opt for more basic accommodations vs. staying in a luxury resort.
In the same vein, people will need to replace their cars, but instead of buying a high-end luxury SUV with all of the bells and whistles, they may opt for a used, more basic mini van to cart around their family, in down economy.
Cyclical Stocks vs. Non-Cyclical Stocks: Differences
The performance of cyclical stocks will tend to follow the ups and downs of the general economy far more than that of non-cyclicals. Their price and performance can be quite volatile.
Investing in cyclical stocks needs to be done with care. A portfolio loaded with cyclicals can do quite well when the economy is booming but can take a severe hit when things head south. As we've discussed, many of the products and services offered by the companies behind these stocks can be forgone by consumers who are concerned about their finances or who may even be suffering a job loss in the down economy.
This isn't to say that investing in cyclical stocks should be avoided, quite the contrary. But as with any type of investment, it's important to understand the dynamics of the company and its stock before investing in it. With cyclicals, investors can make a lot of money buying them in a down economy in some cases.
As an example, an investor who would have purchased shares of high-end jeweler Tiffany & Co. (TIF) - Get Tiffany & Co. Report at the end of October of 2008 and held it until July 31, 2019 would have realized a gain of 324.77%. During this same period of economic growth, the S&P 500 gained 286.95%, according to data from Morningstar.
Non-cyclical stocks tend to outperform cyclicals when the economy slows. These stocks are also sometimes called defensive stocks.
These companies tend to sell products and services that are considered essential and largely not impacted by economic trends. Companies that sell essential products like soap, toothpaste and basic food items would fall into this group. Utilities are an example of services that fall into this category. Regardless of the economy, consumers and businesses still need heat and electric services.
Looking at an example of the stock performance of a cyclical vs. a non-cyclical stock during calendar 2008, the main portion of the financial crisis, illustrates how these two types of stocks can differ in performance in a down economy. Data used is from Morningstar.
During 2008, the stock of Ford Motor Company (F) - Get Ford Motor Company Report lost 65.97% on a total return basis. By contrast, the stock of Duke Energy Corp. (DUK) - Get Duke Energy Corporation (Holding Company) Report "only" lost 21.60% during the same time period.
Auto makers are widely considered to be cyclicals. Utilities like Duke Energy tend to be more defensive in nature.
Examples of Cyclical Stocks
We've had both a rising stock market and strong economy for the last decade since the end of the financial crisis. Going back to the period of the financial crisis provides many examples of cyclical stocks that were hit hard by the slumping economy and the pronounced drop in the stock market. Here are several examples of cyclical stocks that were hit hard. The period of time used was Dec. 31, 2006 through Dec. 31, 2009. The analysis was done using data from Morningstar.
Wynn Resorts (WYNN) - Get Wynn Resorts Limited Report , Limited
The company is the owner and operator of a number of resorts, hotels and casinos. Many of their properties are upscale, luxury type locations.
The cumulative return of the stock during this time period was -30.99%. This is almost double the loss experienced by the S&P 500 over the same period of time, -15.95%.
The company operates several cruise lines. Cruise line stocks are a great example of a cyclical stock. Taking a cruise is totally a discretionary expense that people can and will forgo when the economy is soft.
The cumulative return of the stock during this time frame was -36.86% compared to the S&P 500's return of -15.95%.