Cyclical Stocks

The seasons change, and so does the demand for a lot of items in the market. Consider the example of ice-creams. In the northern part of India, with the onset of March- April the demand for ice-creams start rising because of the increasing temperature. This same demand is reduced as soon as the season changes. Cyclical stocks in the Indian stock market work more or less on the same phenomenon. 

Just like the name indicates, the cyclical stocks work just like a cycle moving uphill and then sliding down. These stocks can often put your portfolio in a good light. So, in this article, we will try to understand the entire concept of cyclical stocks.

Let’s begin!

What are Cyclical Stocks 

Cyclical stocks are a type of equity stocks that function in accordance with the business or economic cycle. This means that they rise and fall according to the trends in the economy. 

Philip Kotler rightly says “Watch the product life cycle, but more important, watch the market life cycle.” This is the case with cyclical stocks as well. To understand its proper working, you have to be very watchful of all the economical changes around you.

The interdependence of cyclical stocks on economic cycles makes it important for an investor to possess knowledge of the business cycle as well. A business cycle usually comprises 5 phases: expansion, peak, recession, trough, and recovery. 

The prices of the cyclical stocks rise with the expansion and peak in the business cycle. And the prices fall when the economy is sliding into depression. 

This is because, when the economy is on a positive run, the people in the market usually have an optimistic approach. While there is an increase in income as well, people spend their capital more on luxury items or other items in general. When the demand increases, the companies associated with the items also increase. 

Now with this, the share prices also see an uptrend. Gradually when the economy moves into a recession zone, the demand for the products is also affected. This is because of the limited spending of the individuals and lack of employment. 

Due to this economic slowdown, the prices of the cyclical stocks also go down because of the low demand of the products. 

So, this is how cyclical stocks work. They plunge up when the economic conditions are on a boom and move downwards in times of recession.

Let us understand the cyclical stocks with the help of an example. 

Cyclical Stocks Examples

Have you ever seen a surfer surf? They wait for a wave to ride it to the shore and as soon as the wave settles down, the surfer also stops. This goes the same in the case of cyclical stocks as well. They ride with the highs of the business cycle and come down as soon as it settles.

If we take it to the stock market, then we can consider the hospitality industry. Now when there is a boom in the economy, the public, in general, is also devoted to spending on luxurious life and has an inclination to take vacations. 

Now, with this, the stocks of the same industry will also see an uptrend. But when the economy slows down, the trend of travel also smoothens and hence a decrease in prices of the stocks as well. 

This was very well evident during the Covid lockdown in 2020. As the whole world and economy were put on hold, the hospitality sector suffered major losses. But as soon as the lockdowns started lifting, the travel and hospitality industry started regaining its momentum. 

Another example of cyclical stocks can include automobiles, luxury bags, consumer foods, etc.

Cyclical Stocks Sectors

The economic conditions of a nation or even the world undergo different phases. Ever since the inception of the coronavirus, the economy of not just the third-world nations, but also the first-world nations have suffered to a large extent. 

Now, with the decrease in the adversity of the pandemic, the economy of major countries have started gaining momentum. But the question here is, will the economy always thrive? And if not, are there any particular sector’s stock that you should keep in your portfolio so that you don’t have to suffer the wrath of losses even in adverse times? 

This is the reason a lot of investors choose the cyclical sectors amongst the different sectors in stock market. Let us have a look at the different sectors that can help you invest in accordance with the business cycle. 

Capital Goods Sector 

One of the prominent sectors in the cyclical stocks sector is the capital goods sector. The capital goods are used in the manufacturing and production of different products. These are only used to achieve the final results.

Manufacturing, equipment, industrial units, printing, and packaging machinery are some of the common areas that are a part of the capital goods sector. 

The capital goods have a direct impact on the manufacturing of the products so naturally, when the economy goes into a sinking zone, the entire system is affected. The prices of the majority of the goods will move downwards and therefore the overall price of all the capital goods will also decrease. 

Banking Sector

It is obvious that when there is a change in the economy, it will directly impact the BFSI sector. All the retail, private, insurance companies, and financial companies are included in this sector. 

Now take an example of when the pandemic first struck. All the sectors were affected that including the banking sector as well. Although it was not affected directly, the degrading economic health of the other sectors impacted it as the companies that went out of business were not able to repay their loans and this ultimately impacted the capital of the banks. 

In addition to this, the banking sector was forced to shell out the finances to help the people and businesses affected during the pandemic massively because of an increase in the credit demand. 

But when after a certain time, when things started to normalize and the lockdown ended, the banking sector played an important role in the recovery of the economy. This is how the banking sector stocks ride with the business or the economical cycle. 

Auto Sector 

Another sector that is readily affected by the changes in the business cycle is the auto sector. When the economic conditions are in the good run, an individual might have good savings and an intent to purchase a vehicle. And this is often seen during the time of economic peaks as well.

But with the decline in the economy, the demand for automobiles might plunge down causing a decline in the prices of the stocks of the sector as well. 

This is why the stocks of the automobile sector are classified as cyclical stocks as the changing demand, also causes the decreases in the stock prices. 

These are some of the sectors in the stock market that are directly or indirectly affected more with the changing phases of business or the economical cycle.

Advantages of Cyclical Stocks 

Now that we know the meaning of cyclical stocks, it is also important to understand whether or not it has some benefits for the investors. The advantages of cyclical stocks are listed below. 

  • They have the potential of generating high returns. If there is a boom in the economical conditions of a country, then picking the best cyclical stocks at the right time can yield great returns for an investor.
    The conditions and mindset of the market are also optimistic during a peak in the economical cycle, causing the prices to further move upwards. This again helps in generating good wealth for the investors.
  • Since cyclical stocks are usually the manufacturing or luxury goods companies, they are easier to identify in the stock market. Another factor that makes them easier to identify is massive fluctuation in their prices in accordance with the change in the business cycle. 
  • If you keep a regular track of the GDP, the performance of cyclical stocks can be easier to predict. Even if you are a beginner in the stock market, you can make investment decisions based on the current economical conditions in the market and invest in cyclical stocks. Their performance is easier to predict because, with the initiation of a recession zone, their prices will also go down. 

Disadvantages of Cyclical Stocks 

Just like there are a lot of advantages of cyclical stocks, there are some limitations as well. Let us discuss them in brief so that you are well aware before investing. 

  • Cyclical stocks have the potential to generate high returns, but this comes with high risk. This is because there are major fluctuations in these stocks because of the changes in the economical cycle.
  • The profits are not certain or guaranteed since everything is dependent on the economical cycle. In case of a misjudgment, things can move against your will as well.  

Now that we have looked at the advantages and disadvantages of cyclical stocks, the other question is should you invest in the stocks and how to trade them. 

How to Trade Cyclical Stocks

Cyclical stocks surely have the potential to generate great returns if done the right way. The first thing that you should consider before investing in cyclical stocks is your capital and risk appetite as cyclical stocks are usually considered riskier. 

A lot of investors often suggest, ‘buy at dip’, this is particularly efficient in the case of cyclical stocks as well. The right way to invest in cyclical stocks is during the recession phase, as when the market overcomes and recovers gradually, it has the potential of generating great returns. 

It is also important that you choose the industries that have the potential for recovery. The large companies in this case as well offer a great advantage over the smaller ones. 

Another important factor to trade cyclical stocks is that, if you are looking to earn profits from dividends or bonuses, then always invest when the company has started to recover. It is only after this that the company will make profits and hence distribute dividends to the shareholders. 

So, trading in cyclical stocks definitely needs a good understanding of the business cycle. But apart from this, it also needs the selection of the right companies and the patience to wait for the right time. 

Conclusion

Cyclical sectors have the potential to generate great returns if the investor is in sync with the business cycle. One has to choose the right company and calculate their risk appetite so that there are chances of maximum profits. 

If you are looking to invest in cyclical stocks, then you can choose different sectors including capital goods, banking sectors, auto sectors, healthcare, etc. You can always weigh your risk appetite, objectives, and the capital that you want to invest in and then choose the favorable phase of the economical cycle to invest your money. 

The cyclical sectors ride the tide of the business cycle and hence one can derive benefits from it. If you too want to start your investing journey, you can open your demat account today.

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