Cyclical stocks are stocks that tend to move with the current economic trend. When the economy is growing, the value of the shares of a cyclical stock will increase. During periods when the economy is undergoing some type of downturn, the stock will decrease. Typically, cyclical stocks are associated with industries in which there is some shift in demand based on what is occurring in the economy, and not with industries where the demand tends to remain constant.
One example of an industry where cyclical stocks are found is the automotive industry. When the general economy is growing, consumers have more disposable income on hand, and are more likely to purchase new automobiles. This upswing in consumer demand continues as long as economic growth is taking place. Should the economy begin to stall, and households no longer have as much disposable income as before, the end result is that the demand for new vehicles decreases, which in turn causes the value of the stock issued by automakers to decrease.
Cyclical stocks can also exist in specific sectors of various markets. During an economic downturn, consumers may purchase less of one particular type of good while increasing their demand for other goods. This is true when it comes to food. When there is less disposable income, a household may purchase less meat each week, and use a portion of those savings to purchase various types of beans as replacements for the meat. In this scenario, the securities issued by companies that product meat as their primary product offering will decrease slightly, owing to the change in demand. The demand for beans as a replacement for the meat can create what is sometimes called a counter-cyclical stock increase, since that increase can be directly connected with the economic downturn and the ensuing change in consumer purchasing habits.
It is important to note that investors do not have any control over the movement of cyclical stocks. This makes it all the more important to accurately project the direction that the economy will move in both the short-term and the long-term. Doing so makes it possible to structure trading strategies that allow the investor to buy shares of stock that are likely to thrive in the upcoming months and years, while selling off stock that is likely to tumble in value during that same period. Creating the right combination of purchase and sales result in riding the economic trend to its obvious conclusion, and increasing the potential of earning a consistent return.
