The most seasoned investors recognize that the best way to play the stock market is to look to the past and identify patterns. This is due to the cyclical nature of the financial markets. Looking to the past to predict future market behavior sets apart investors from speculators. As we will see, cycle shifts take place through exogenous events, as well as technological, political, and cultural shifts. The study of the cyclical stock, is a highly crucial one, as it is a science that gives market players an edge above the wider market. Through this, investors can predict market behavior based on historically consistent trends.

In this article, we break down the concept of cyclical stock and discuss how it can be used to implement a winning market strategy with relatively low-risk exposure.

Armed with this knowledge, anyone can use history as a guiding light to look forward, and maximize profits!

What Is a Cyclical Stock?

A cyclical stock is simply a stock whose performance is tied closely to a business cycle. This makes it because the company’s performance is highly sensitive to economic conditions such as interest rates or inflation levels.

During business booms, these stocks typically take off, when revenue and earnings are growing impressively. Alternatively, during economic busts, the resulting business slowdown causes these stocks to undertake drops.

Examples of such stocks with a cyclical nature are those belonging to the automotive, leisure or travel industries. These industries see phenomenal growth when the economy is in a takeoff mode, and when employment is generally high.

With high purchasing power and macroeconomic stability, cyclical industries take off spectacularly. When economic conditions take a dip so do stocks belonging to these industries, due to their inherently cyclical nature.

Understanding Cyclical Stocks

Now that we know what is a cyclical stock, we take a more in-depth view of its inner workings to understand what this stock class is all about.

Stocks that swing along with cycles are an ongoing reality in the financial markets. This is because, cyclical trends in the market are a natural phenomenon, which is stimulated by fluctuations in the economy.

At its core, the turning market cycle can best be assessed in terms of supply and demand. Demand is affected by consumers’ spending behaviors, and supply is due to obstructions producers may be facing.

Looking at the example of a recession, consumer spending falls significantly for cyclical industries, which in turn impacts the profitability of these companies. The result, therefore, is a drop in stock prices.

Over time, the cycle of expansion and retraction is continued perpetually. Those that recognize these consistent swings can make more informed decisions about the entry and exit points of their investments.

Special Considerations

As has already been discussed above, the cyclical stock is sensitive to economic cycles, and hence its trajectory is in line with the patterns they form. However, there are other special considerations about these stocks, which are as follows:

• Timing

  Timing is the most critical aspect for cyclical investors. Identifying beginnings and ends to economic cycles would allow for these stocks to be bought at lows and sold at highs. This essentially relates to the execution part of the strategy.

• Volatility

  Due to its sensitivity, a cyclical stock may be a lot more volatile than non-cyclical stock. This increases its risk exposure, making it wildly erratic, especially during times of economic uncertainty.

• Industry-Specific Factors

  There may be factors to consider that are specific to certain industries that may impact their seasonality along economic cycles. For instance, certain industries, such as industrials, may be especially sensitive to government policy.

• Diversification

  Cyclical investors must ensure that their portfolios are well-diversified, due to the volatile nature of such stocks. This approach would optimize one’s cyclical investment strategy, and address the risks to it.

Cyclical vs. Non Cyclical Stocks

Cyclical and non-cyclical stocks are distinct stock categories, which have a range of differences between them. These are discussed below as follows:

• Cycle sensitivity

  The foremost difference between cyclical and non-cyclical stocks lies in their sensitivity to economic cycles. While the former may show a high degree of sensitivity to these cycles, the latter holds no such association.

  In fact, the positive performance of non-cyclical stocks can very well continue, even during economic downturns and recessions.

• Volatility

  Stocks of cyclical companies are often volatile due to the high beta they hold, whereas the same is not necessarily true for non-cyclical companies. This makes non-cyclical stocks a better pick for those with low-risk tolerance.

• Nature of business

  Cyclical companies often derive a major portion of their revenue from luxury or discretionary spending, whereas non-cyclical companies do so from essential goods and services.

  This explains the stock performance of each category, as discretionary industries are the first to see demand drop during times of stress, whereas demand remains unchanged for non-cyclical businesses.

Example of Cyclical Stocks

We now move on take a look at some examples of cyclical stocks, making them great picks for those looking to ride a cyclical growth strategy.

• Airlines

  The airline industry is highly cyclical because air travel is an example of discretionary spending, and people are far more likely to spend money traveling by air during economic booms than in downturns.

• Hotels

  Just as the case with the airline industry the hospitality industry is also tied closely to economic conditions. Demand for hotels is at its peak when disposable incomes are at their highest.

• Retail

  Because purchasing power is tied directly to macroeconomics, retail businesses are among the first to take hits on their profit margins amid slowdowns. This is due to their high sensitivity to economic cycles.

• Restaurants

  When economic times are good, there is a greater tendency among people to dine out at restaurants, in comparison to recessions. When employment is high, and the economic indicators are good, the restaurant industry is sure to be booming.

• Automakers

  Automakers are a prime example of a cyclical industry, with the broader market being at its most active during economic highs, and demand falling flat amid difficulties.

Best cyclical stocks to buy in 2023

Now that we have a solid idea of the cyclical stock, and how to profit off its predictable nature, we can turn to look at some of the greatest picks for 2023. These are described in the following cyclical stocks list:

• The Walt Disney Company

  The Walt Disney Company (NYSE: DIS) is the dreamland destination for those looking to create magical memories.

  The company’s theme park division is its core money-maker and is expected to surge with hints of economic recovery. The stock is currently trading at the lower end of the cycle, spelling a strong boom opportunity for cyclical investors.

• Expedia

  The online, American travel company, Expedia Group Inc. (NASDAQ: EXPE) is another great cyclical pick to go with. Despite strong top and bottom-line growth, the stock is still trading at 2015 levels.

  It is evident that EXPE is on a down spell with present market conditions, and its rise would be inevitable as the macroeconomic landscape clears up.

• EPR Properties

  The REIT, EPR Properties (NYSE: EPR) is a stock that has its performance closely associated with discretionary spending. This is because the overwhelming majority of its tenants are in the movie theater industry.

  Despite threats from streaming giants such as Netflix and Amazon Prime, the movie theater experience remains dear to viewers and is likely to surge with economic improvement.

• Nucor

  Nucor Corporation (NYSE: NUE) is a great pick for those looking to bet on growing steel prices. Nucor, the dividend king, is ideal for 2023, which many believe is the year the steel cycle makes a rebound.

Examples of Defensive stocks

One category worth mentioning in our discussion is defensive stocks. These, although not sensitive to economic cycles, show an inverse relationship such that they perform well during periods of economic dips, rather than booms.

Some examples of defensive stocks include

• Procter & Gamble (PG):

  A consumer goods company that produces household and personal care products

• Johnson & Johnson (JNJ):

  A healthcare company that produces pharmaceuticals, medical devices, and consumer health products

• Coca-Cola (KO):

  A beverage company that produces soft drinks, juices, and other non-alcoholic beverages

• Walmart (WMT):

  A retailer that sells a wide range of consumer goods, including groceries and household essentials

• Duke Energy (DUK):

  A utility company that provides electricity and gas to customers in the United States

Conclusion

A cyclical stock is a stock of a company whose performance is highly correlated with the business cycle. These companies are usually positioned within industries that show a high degree of sensitivity to economic circumstances.

Knowing which sectors experience booms and declines along with the economic cycle due to shifts in purchasing power, inflation, and interest rates could really help investors make sound predictions about stock trajectories.

It is important to beware of the risks of stocks of a cyclical nature because these typically show a high degree of volatility in the short term. Investors often address this through diversification and the inclusion of defensive stocks in their portfolios.

FAQs

Which sectors are cyclical?

Cyclical sectors are those that are highly sensitive to economic fluctuations and tend to perform well during periods of economic growth, such as consumer discretionary, industrials, materials, and technology sectors.

What are the best cyclical stocks now?

The best cyclical stocks to pick now, in 2023 are The Walt Disney Company, Expedia, EPR Properties, and Nucor. These are highly likely to see a booming performance with the anticipated economic recovery this year.