What are cyclical stocks and how do you trade them?

What are cyclical stocks?

Cyclical stocks are the shares of companies that change depending on the economic circumstances of a country or stages in the business cycle. In periods of economic prosperity, high employment and productivity, cyclical stocks will rise in price, and in periods of recession – when businesses contract and employment rates fall – the stocks will decline.

Most cyclical stocks are companies that sell consumer discretionary items – goods and services that are not seen as vital, such as travel, entertainment, auto manufacturing, building construction, and luxury retail. These industries will be boosted when spending is on the rise but are left on the shelf when saving begins.

Especially following Covid-19, the best way to think of cyclical stocks are those that were not considered ‘essential’ during each of the lockdowns. This was everything from high street retail shops and pubs to hairdressers and cinemas.

Cyclical stock examples

Cyclical stocks are classed as ‘discretionary companies’. The industries that fall into this category include examples such as:

• Car manufacturers: during economic booms, consumers are more likely to spend money on new cars and buy into the latest models on the market, but in recessions, people tend to keep their current cars going for as long as possible. These means automaker sales will rise and fall in line with economic cycles
• Airlines: travel is often one of the first things to stop in an economic downturn. Individuals and businesses will cut their expenses for international travel, favouring staycations and electronic conferencing tools
• Hospitality: just like airlines, hotel revenues will depend on the number of tourists and business clientele coming in – which is likely to be much higher during economic booms
• Retail: consumer spending on retail goods – clothing, furniture, beauty products, jewellery and so on – is always much higher during periods of economic growth. However, some retailers that sell consumer essentials, such as supermarkets, healthcare shops and cleaning suppliers, are countercyclical – they experience income whatever the economic situation
• Restaurants: when there is little spending, people tend to eat at home rather than spending money eating out. Although it’s worth noting that during Covid-19, takeaways through delivery services such as Deliveroo were extremely popular
• Technology: while big tech stocks often continue to see growth in economic downturns, smaller manufactures and electronic device makers are often dependant on consumer spending
• Banks: in economic slowdowns, banks often decline in profitability due to the reduced demand for mortgages, loans and credit cards. Plus, as interest rates fall, so will banks’ profits

Cyclical stock list

US cyclical stocks

• JPMorgan Chase (JPM) – banking and investment services
• Apple (AAPL) – consumer electronics
• General Motors (GM) – automotive manufacturing
• Boeing (BA) – airlines

UK cyclical stocks

• Burberry Group plc (BRBY) – luxury retail
• Easy Jet (EZJ) – airlines
• ASOS Group (ASC) – online retail
• InterContinental Hotels Group (IHG) – hospitality

EU cyclical stocks

• DSV Panalpina (DSV) – freight
• Michelin (ML) – automotive parts manufacturing
• Deutsche Bank (DBK) – banking and investment services
• LVMH (MC) – luxury retail

It’s important to note that just because a stock has performed a certain way in one economic downturn, does not guarantee that it is a perfectly cyclical stock. Depending on the circumstances, a recession could boost typically cyclical industries.

For example, the Covid-19 recession led to a boost in online retail stocks – such as ASOS and Boohoo – as stay-at-home measures encouraged e-commerce. However, usually retailers are some of the first companies to suffer as spending falls.

There are also cyclical stock exchange traded funds that can give you a broader exposure to discretionary companies. For example, the SPDR series Consumer Discretionary Selector Sector ETF, which is based on sector rotation – meaning it changes depending on which parts of the US stock market are performing well in a period of recovery.

How to identify cyclical stocks

The most common way of identifying cyclical stocks is by looking at the beta value of the stock. The beta value looks at how sensitive a share price is to changes in the broader market by comparing returns.

A beta value of one means the share price changes in line with the broader stock market, generating even returns. A beta value higher than one indicates that the stock is much more volatile than the market benchmark. Cyclical stocks nearly always have beta values that are higher than one.

Cyclical vs non-cyclical stocks

While cyclical stocks are impacted by the business cyclical, non-cyclical stocks aren’t. They’re often known as defensive stocks or consumer essentials, as their performance is durable in both contractions and expansions.

That’s not to say defensive stocks aren’t susceptible to recessions, but their share price movements aren’t usually as dramatic as cyclical stocks. This is also true during periods of economic expansion – non-cyclical stocks tend to be steady earners, while cyclical stocks experience rapid and dramatic growth.

Common examples of non-cyclical stocks include:

• Essential retail – big supermarkets, healthcare companies and cleaning suppliers
• Utilities – electric, gas and water companies
• Healthcare – pharmaceuticals, biotech and medical suppliers

Are cyclical stocks worth trading?

Cyclical stocks are a worthwhile part of any trader’s portfolio for three main reasons:

1. Volatility. Cyclical stocks tend to be volatile, which can create a huge range of opportunities for traders to go both long and short. In periods of growth, buying cyclical stocks can generate better-than-average market returns – for example, between Dec 1998 and Jan 2021, the MSCI USA Cyclical Sectors Index delivered net returns of 6.98%, compared to 6.55% for MSCI USA. Meanwhile, in periods of recession, selling cyclical stocks can provide a way to hedge your portfolio or create profit in a downturn
2. Hidden gems. A common trend in cyclical stock trading and investing is attempting to identify companies that have lost a lot of value in a recession but that have growth potential. This way you can buy in when the stock is undervalued and take advantage of the upward swing.
3. Diversification. Most traders and investors will hold a mix of positions on cyclical and non-cyclical stocks. This way, whether the economy is rising or falling, they’ll likely have one portion of the portfolio making money

When you buy and sell cyclical stocks, there are also a few drawbacks – or rather, things to be aware of before you trade. For example, while volatility can be great for derivatives traders who speculate on rising and falling markets, investors may want to look for stocks with more steady returns.

It’s also important to be aware that timing is everything with cyclicals. These stocks aren’t the type you can just leave to run profits, you’ll have to keep an eye out for market tops and bottoms – you don’t want to buy in only for the stock to fall even further or sell just before the market rallies.

How to trade cyclical stocks

1. Create a CFD and spread betting account
2. Identify your opportunity using technical and fundamental analysis
3. Open your first position
4. Monitor and close your trade