Consumer Cyclical Definition

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Also called “consumer discretionaryConsumer DiscretionaryConsumer discretionary refers to goods and services mostly acquired using discretionary income as they are optional in people’s lives such as designer clothes or luxury cars.read more,” it encompasses businesses that sell dispensable goods and services like designer clothing, automobile, eateries, and entertainment. The stocks of such companies are referred to as cyclical stocksCyclical StocksA cyclical stock refers to that share whose price fluctuates with the change in overall macroeconomic conditions. Such a stock is sensitive to the various economic phases like recession, boom, expansion, contraction, trough, peak and recovery.read more. This is because their movement is usually synchronized with the market. Thus, the risks and benefits of investing in them depend on the investment timing.

Key Takeaways

  • Consumer cyclical is a category of stocks whose performance is sensitive to the economic cycle, increasing when it boosts and decreasing during a downturn. It usually represents stocks of companies selling non-essential products or services like entertainment, high-end gadgets, sports cars, and expensive clothing. Investment in cyclical stocks ensures maximum profitability during an economic upturn and portfolio diversification. It contrasts with “consumer staples,” including basic commodities like food and medicine, which remain unaffected by market shifts.

Consumer Cyclical Explained

The term consumer cyclical denotes stocks of companies that offer products that are affected by economic cycles. Cyclicals flourish when the market is up, and consumers have more spending potential. Nevertheless, it declines when the market is down, and consumers have less spending potential. So, let’s see how it works.

A growing economy results in higher disposable incomeDisposable IncomeDisposable income is an important mechanism to measure household incomes, and includes all sorts of income such as wages and salaries, retirement income, investment gains. In other words, it is the amount of money left after paying off all the direct taxes.read more with its people, enhancing their buying power. People with rising income are more likely to buy a fancy car, eat out at an expensive restaurant, or take a vacation. This translates into profit for companies offering such goods and services, reflected in their rising stock price.

Conversely, when an economy takes a downturn, demand for these items recedes, reducing the earnings Earnings Earnings are usually defined as the net income of the company obtained after reducing the cost of sales, operating expenses, interest, and taxes from all the sales revenue for a specific time period. In the case of an individual, it comprises wages or salaries or other payments.read moreand stock prices of companies producing them. However, people are not likely to curtail their spending on food and medicines even during a slowdown as they are essential for their survival. Such essential commodities are called non-cyclical or consumer staples. They remain unaffected by market changes and enjoy an inelastic demandInelastic DemandInelastic demand refers to the minor change in the demand of the quantity or behaviour of consumers with a change in the product’s price. Common examples of inelastic demand are gas and fuel, electricity, and consumer goods.read more.

Unlike staples, cyclicals suffer a maximum loss during an economic recessionEconomic RecessionEconomic recession is defined as the phase in which economic activities of a country become stagnant, leading to a disturbance in the business cycle and affecting the overall demand-supply balance. read more. This is because people prefer to spend money on consumer staples rather than investing in non-essential items. As a result, the prices of cyclical stocks nosedive.

Consumer Cyclical vs Consumer Staple

Examples

The economic downturn due to the COVID 19 pandemic resulted in several cyclical stocks being affected. One such stock is of global fast-food retailer McDonald’s. With people staying at home and spending on consumer staples during the pandemic, the company’s fortunes took a beating.

The pandemic-imposed restrictions and economic recession led to a fall in its revenue Revenue Revenue is the amount of money that a business can earn in its normal course of business by selling its goods and services. In the case of the federal government, it refers to the total amount of income generated from taxes, which remains unfiltered from any deductions.read morefrom $21.4 billion in 2019 to $19.2 billion in 2020. As a result, stock prices declined from $186 in December 2020 to $140 in March 2020.

However, with the pandemic receding and economic upturn, the company is seeing a revival in its revenue. The company’s earnings have witnessed positive growth and are likely to ride high in the coming months.

A recent Forbes article discusses the ten best consumer cyclical stocks as of March 2022. It also mentions four sub-sectors of consumer cyclical stocks: retailers, automobile and automobile parts, durable household items, and hotels, restaurants, & entertainment.

Here is the list.

Role of Consumer Cyclical in Investments

Cyclical stocks provide the highest gains in a bull market and endure the biggest losses in a bear market. This is because it comprises stocks of industries that are highly dependent upon consumer demand for business sustenance and growth. Consequently, their prices surge in a booming economy and fall when it slows down.

Since cyclical stocks move in tandem with the markets, their performance is based on market timingMarket TimingMarket timing is the plan of buying and selling the securities on the basis of decisions made by financial investors. They do security analysis to earn a profit on selling and it is the action plan to cope up with the fluctuations in the market prices.read more. Therefore, investors must know how to trade cyclical stocks at the right time to obtain the utmost benefits. Nonetheless, it is tough to interpret the right market timing due to an unexpected rebound in certain cyclical before the end of the downturn.

Hence, investors must target cyclical stocks with high dividendsDividendsDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity.read more to diminish the possible drawbacks. The best time to buy cyclical stocks is when they possess high valuation ratios. With perfect investment timing, the volatile consumer cyclical sector provides impressive growth potential. Needlessly, cyclical stocks are suitable for experienced investors with professional insight.

Moreover, a judicious mix of both cyclical and non-cyclical stocks leads to sustained long-term returns with minimum risk. 

When to invest in cyclical stocks?

The investor must buy cyclical stocks when the economyEconomyAn economy comprises individuals, commercial entities, and the government involved in the production, distribution, exchange, and consumption of products and services in a society.read more is growing. This growth happens when:

  • Metals witness the beginning of a supercycleGovernment pushes its capital investmentCapital InvestmentCapital Investment refers to any investments made into the business with the objective of enhancing the operations. It could be long term acquisition by the business such as real estates, machinery, industries, etc.read more cycleFrenzied business expansion occursA significant external investment happens in the economy

Why invest in cyclical stocks?

Investment in cyclical stocks aids in:

  • Ensuring excellent performance in a thriving economyPortfolio diversificationPortfolio DiversificationPortfolio diversification refers to the practice of investing in a different assets in order to maximize returns while minimizing risk. This way, the risk is kept to a minimal while the investor accumulates many assets. Investment diversification leads to a healthy portfolio.read more

Investment in cyclical stocks requires thorough financial knowledge with a backup plan to limit the damage caused by a possible economic slump. 

This has been a Guide to Consumer Cyclical & its Definition. Check out the consumer cyclical companies and sectors & their comparison with non-cyclicals. You may also have a look at the following articles to learn more –

A – Consumer cyclical industries include:· Automakers·  Airlines·  Construction·  Durable goods like industrial equipment·  Discretionary goods like home appliances·  Luxury goods like designer clothing, jewelry, etc.·  Mining·  Finance

A – Consumer cyclical and non-cyclical stocks are two types of stock categories. Cyclical stocks depict companies selling inessential goods and services whose demand is sensitive to market fluctuations. At the same time, non-cyclical stocks portray firms selling basic goods and services whose demand remains unaffected by market changes.

A – Investors must buy consumer cyclical stocks during an economic upturn. When the economy is expanding, people have more money to spend on discretionary items, which is likely to drive their demand up. This increases the profitability of companies producing them, surging their stock prices. As a result, investors can expect a handsome return on their investment.

A – Yes, consumer cyclical is also often known as “consumer discretionary.” Both terms represent companies generating non-essential items whose demand and supply are directly related to the economic cycles.

  • Cyclical IndustryCyclical StocksBusiness Cycle