What are the Cyclical Stocks?

Cyclical Stocks refer to a stock or company security that mimics the country’s macroeconomic environment and provides greater returns when the economy is booming and results in losses when the economy is in bad shape. Examples of cyclical stocks include auto manufacturers, airlines, hotels, casinos, restaurants, etc.

Advantages of Cyclical Stocks

Given below is how cyclical holding stocks tend to benefit the investor.

  • Massive Growth – Cyclical stocks tend to provide massive growth to investors when the economy is booming. The value and prices of such stocks skyrocket as they reflect the increased confidence the consumers have placed in such companies when the economy is growing.Right buy before the beginning of the boom generates great returns. If an investor can identify the period just before the economy starts to boom, he can tend to amass enormous gains. Timing matters while picking cyclical stocks, and if one manages to make the right move just before the economy begins to make the uptick and thus manage to buy such stocks at the bottom of the cycle, which would go on to witness an upturn, they are sure in for a significant gain.Stimulus During Falling Interest Rates – When interest rates in the economy fall, these stocks tend to have better valuations. Interest costs will be low, and earnings thus tend to increase to that extent. It is further reflected in the stock price. Therefore in environments where such interest rates are falling, cyclical stocks do get a massive boost, and hence investors tend to make a lot of money under such circumstances.More Volatile than Benchmark – At times, these cyclical stocks will be more volatile than the benchmark indexes. It will suggest that an investor who can time his purchase and investment in an industry that is heavily dependent on the country’s economic strength, such as the technology sector, would at times be able to generate returns above the benchmark index of the particular country.Reflective of Business Sentiment – One can consider cyclical stocks to reflect business sentiment in the economy. Thus, one may gauge where the economy is headed by very well understanding the movement of such cyclical stocks. They tend to rise during times of expansion and gradually decline during phases of recession. Thus, they mirror the business cycleBusiness CycleThe business cycle refers to the alternating phases of economic growth and decline.read more and sentiments that prevail in the economy.

Disadvantages of Cyclical Stocks

Given below are some of the disadvantages of cyclical stocks.

  • Major Fall during Times of Recession – Since cyclical stocks tend to reflect the country’s business cycles, during times of recession, they do witness a significant fall in value. Investors who do not manage to sell off their stocks before the onset of economic decline will have to bear such enormous losses owing to a fall in the stock prices of such stocks.Timing Matters – As for cyclical stocks, the timing during which you buy them does matter, and should one make the mistake of having to enter into the purchase just when the economy starts to slide down from the top and thereby later sell at rock bottom at bad prices, it indeed is a recipe for disaster. Careful analysis is required before having to buy such stocks.High Volatility – Another major disadvantage of having to do with cyclical stocks is that they are volatile. They tend to fluctuate greatly with the current scenario and conditions prevalent in the economy. They may, at times, go too far from the current levels and the benchmarks, even heading down south way more than the levels that the current benchmark would tend to be at.Requires Careful Analysis – For cyclical stocks, careful analysis and understanding are required due to their volatile nature. It becomes imperative that one always follows the markets and is very well aware of the upcoming signs. Only when one can dedicate sufficient time to follow the market would they know and understand the current trends and thereby decide when to enter and when to exit the market to take advantage of market movement and business cycles.Not for the long term and Passive Investors – Generally, long-term investors tend to be passive and do not involve regular active buying and selling. They do not bother to follow the markets frequently. They believe in the tenet of having to ‘Buy right and sit tight.’ Hence, when the economy is in a recession and if the long-term investor holds cyclical stocks, they cause significant erosion to his holdings’ value due to the fluctuating nature of the cyclical securities.

Hence it is not advised for the long-term and passive investors as they may have to wait for 7-10 years before the economy begins to pick up from the downfall. However, if they are reasonably well-diversified, that need not be the case.

Conclusion

Cyclical stocks owing to their fluctuating nature, tend to be very volatile and will be reflective of the business sentiment prevalent in the country. Hence because of the mirror reflection that they tend to adopt the economy, they tend to be wealth creators when the country is going upward. Hence, they tend to increase in value, thereby reflecting the country’s positive business and investment sentiment.

However, at times of recession, they tend to lose enormous value due to the fall in prices and panic that would exist in the market. Therefore, timing does matter a lot when buying such securities, and thus careful analysis is required before making any trade decisions. Not being suited for passive investors would only suit such investors who would carefully follow the market and undertake the required research and analysis.

This article has been a guide to Cyclical Stocks and its definition. Here we discuss examples of cyclical stocks along with their advantages and disadvantages. You can learn more about financing from the following articles –

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