The stock market offers attractive opportunities of trading different types of stocks.
While the moves of the stock market itself affect all stocks, there are plenty of other factors – from the fundamentals of a company to overall economy.
Today, we shall discuss detailed differences between cyclical and non-cyclical stocks.
So, let’s get started!
Cyclical stocks, also known as offensive stocks, refer to shares that follow the ups and downs of the economy as a whole. In other words, cyclical stocks are those that are economically sensitive.
They become inactive during recessions and profitable when the economy is doing well.
Particularly following the coronavirus pandemic, the best way to think of cyclical stocks are those that were not termed “essential” during each of the lockdowns. This included everything from cinemas to pubs to high street retail shops and hairdressers.
Their price and often the underlying results of the company, are affected by the various the stages in the business cycle and economic circumstances of a country.
The performance and price of cyclical stocks can be quite volatile.
However, since the reaction to changes in some economic factors is often quite predictable, experienced stock traders will trade cyclical stocks according to their estimate of changes in these economic factors.
During times of economic prosperity, low unemployment, high productivity and consumer spending, the value of cyclical stocks tends to go up. But in periods of recession when employment rates fall and businesses contract, these stocks decline.
Cyclical stocks can belong to a number of different industries. Unlike many growth stocks, the ranks of these stocks can include large, well-established businesses, as well as smaller ones.
Most cyclical stocks are businesses that offer goods and services that are not deemed as vital, such as entertainment, luxury retail, building construction, travel, and auto manufacturing.
These sectors tend to get a boost when consumer spending is high but are disregarded during periods of economic uncertainty, layoffs, and low unemployment.
Examples of cyclical stocks include American Airlines (AAL), which operates a network air carrier, providing air transportation for cargo and passengers.
Benefits of trading cyclical stocks
There are many reasons why buying and selling cyclical stocks is such an enticing profit-making making opportunity for traders. Let’s take a look at a few of them:
- Traders can make their own buy and sell decisions
- You can use rigorous analysis to decide when to buy and sell
- You have plenty of chances to make money
Best time to buy cyclical stocks
Generally, the ideal time to buy offensive stocks is:
- When there is major stimulus in the economy such as a trillion dollar infrastructure program from the government.
- When there is frantic capacity expansion is happening in the economy as this means cyclical companies can be able to handle additional demand without any additional investment.
- When commodities such as iron, aluminum, palladium, copper, oil and timber are seeing the start of a super cycle.
The opposite of cyclical stocks is non-cyclical stocks. Non-cyclical stocks or defensive stocks tend to do well even during economic downturns.
Simply put, these stocks behave like they are on the defense, countering the broader market movement even when an economic recession is ongoing.
Non-cyclical stocks generally belong to well-established companies that sell products and services people always need. These companies also have stable operations and strong cash flows with the ability to weather worsening economic conditions.
Additionally, they pay dividends, which can have the effect of cushioning the price of their stocks during a market decline.
These companies tend to offer goods and services that are seen as essential and largely not affected by economic trends. Businesses that sell essential goods like basis food, drinks, tobacco, toothpaste and soap would fit into this category.
These are items that experience continuous demand during economic recessions, hence making them solid defensive securities for unpredictable times.
Examples of non-cyclical stocks
Utility companies are a good example of businesses that fit into this group. Businesses and consumers still need electric, water, gas, and waste management services regardless of the economy.
Staples like toiletries, tobacco products, household goods, and food and beverages likely are highly unlikely to be eliminated even when consumers are slashing their budgets to bare-bones necessities.
Tyson Foods (TSN) is a great example of a non-cyclical stock. This food company sells many food products including pork, beef and chicken as well as fresh, refrigerated and processed food products to wholesalers and retailers.
People keep buying its products regardless of the state of the economy. Its main strength is its ability to provide different types of meats all year round.
Demand for beef, chicken, and processed food products like hot dogs tends to increase during the summer and the spring and slumps in the winter.
Demand for pork and other processed foods like breakfast sausage and frozen pies falls in warmer weather and rises in the winter.
Another product or service that consumers will continue to purchase in an uncertain economy is healthcare. Companies such as Johnson & Johnson (JNJ) have performed well over through recessions in the past.
While non-cyclical stocks defend a portfolio from losses, they don’t tend to offer much growth potential. However, they perform consistently even during economic recessions, when other stocks are sinking.
Benefits of trading non-cyclical stocks
Now that you know what are non-cyclical stocks, let’s look into the benefits these stocks offer.
- They repeatedly outperform the stock market when economic growth cools
- They tend to offer more stable returns to traders that hold a long position
- Their prices are less volatile and easy to predict
When it comes to deciding whether you should trade cyclical or trade non-cyclical stocks, the answer would be always to stick with what works the best for you because there are pros and cons to each type.
In the end, your decision will be determined by your attitude toward risk and personal preferences and you need to consider your financial goals and trading strategy.
Regardless of what option you choose, you need a reliable online broker with an efficient trading platform to help you trade.