Like commodity, income and pink sheet equity offerings, cyclical stocks are a very specific type of corporate listing. Featuring unique tendencies in price action, cyclical stocks are frequently targeted for active speculation as well as portfolio diversification.
What Is A Cyclical Stock?
A cyclical stock is an equity product that experiences pricing fluctuations in concert with the prevailing macro economic trends of the day. Accordingly, stock prices typically exhibit bullish and bearish tendencies during periods of economic expansion and contraction. Recessions, depressions and stagnant business conditions all greatly impact consumer behaviour, thus the relative values of cyclical stocks.
At the core of a cyclical stock's valuation model is the tendency to react positively to periods of economic boom and negatively to those of bust. This is due in large part to the levels of discretionary income and spending patterns exhibited by consumers.
Discretionary income is the amount of money a household has after satisfying living expenses and any other financial obligations. This pool of capital is prone to flourish during times of economic expansion, as wages and employment levels increase. Accordingly, spending on durable goods, luxury items and real estate typically grow.
Conversely, discretionary income falls during a contraction as the availability of excess capital becomes restricted. This leads to increased saving rates and reduced spending on non-essential goods and services.
Cyclical Stocks And Discretionary Income
Cyclical stocks are debt offerings from companies that produce goods and services targeting the discretionary income of consumers. The following are a few of the primary industrial categorisations:
The performance of commercial banks, brokerage firms and financial advisors is commonly linked to macroeconomic cycle. Growth in discretionary income can lead to increased capital investiture, which may boost the performance of the financial sector—and vice-versa.
Household purchases of durable goods increase and decrease due directly to capital constraints. The performance of companies that specialise in the production of durable goods, such as appliance and automobile manufacturers, rely heavily on consumer trends.
Demand for luxury goods or services is extremely cyclical in relation to income level. Jewelers and high-end clothing manufacturers are two luxury providers whose welfare depends upon robust economic performance.
Airlines, cruise ships and hotels are three travel industry staples whose profitability is closely linked to macroeconomic cycle.
Popular Ways To Engage Cyclical Equity Markets
Trading or investing in cyclical stocks may be accomplished in a collection of unique ways. You are able to purchase individual corporate shares, mutual funds, exchange traded funds (ETFs), or buy/sell contract-for-difference (CFD) products based on these offerings. The following are a few popular modes of engaging the cyclical equities markets:
The outright purchase of corporate shares is a direct way to engage cyclical stocks. American Airlines (AAL), Tiffany & Co. (TIF) and Goldman Sachs Group (GS) are three examples of popular issues.
For long-term investiture or portfolio optimisation, mutual funds are a common choice among investors. Highly regarded offerings are the Vanguard Consumer Discretionary Fund, Fidelity Select Retailing Portfolio and Rydex Leisure Fund.
In the same vein as mutual funds, cyclical ETFs furnish participants with a professionally managed portfolio of holdings. Some of the most popular are the Consumer Discretionary Select SPDR Fund, Vanguard Consumer Discretionary ETF and iShares Global Consumer Discretionary ETF.
CFDs give international traders the ability to buy or sell derivatives products based upon the value of cyclical stocks. Security offerings vary broker-to-broker, but they often include stocks that are cyclical in nature.
Ultimately, it is up to the individual trader to decide which vehicle is best suited to resources, goals and objectives. For those interested in capitalising on long-term consumer trends or portfolio diversification, purchasing stock or investing in mutual funds may be best. On the other hand, CFD products and ETFs may be more suitable to active traders given that the primary goal is to generate immediate cash flow.
In either instance, cyclical stocks offer a vast array of potential opportunities. When addressed within the context of a comprehensive trading or investment plan, they can be an invaluable financial asset.
A cyclical stock is one that exhibits a positive correlation to both economic expansion and contraction. Its value depends largely upon the levels of discretionary income available to consumers. As discretionary spending increases, stock price rises; as it decreases, stock price falls.
Traders and investors alike are able to capitalise on the distinct behaviour of cyclical stocks. Mutual funds, ETFs, CFDs or corporate shares offer unique functionality that can be useful in long-term investment and short-term trading. From portfolio diversification to speculative enterprise, these securities are useful in managing equities market exposure from a macroeconomic standpoint.
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…