Differentiating between Cyclical and Non-cyclical Stocks
Although it is true that investors have no control over the cycles of a country’s economy, they are able to adjust their investing practices to cope successfully with the economy’s highs and lows. Having a well-balanced investment portfolio is dependent on an understanding of how industries are influenced by the economy before making stock market investments. For this reason it is important for investors to know the fundamental differences between cyclical and non-cyclical stock companies.
What Is the Difference Between Industry Cyclical Stocks and Non-Cyclical Stocks?
To understand the difference between cyclical stocks and non-cyclical stocks, you need to define each type of share. Let’s begin with cyclical stocks.
Cyclical industry stocks involve items that consumers usually buy when the economy is on an upswing, or when there is a high amount of confidence in buying. A good example of a cyclical stock is a car manufacturer stock. Consumers are more likely to buy a car when the economy is healthy rather than in a slump.
Therefore, a cyclical stock may apply to luxury products and services as well, such as five-star restaurants, accommodations, or spas. You might also consider construction-related stocks as cyclical stocks, as new homes are built or building extensions added during times of prosperity.
Other cyclical stocks include those stocks related to brand clothing lines, large appliances (washing machines, refrigerators, etc.), electronic goods, and travel. If the economy slows or the interest rate rises, cyclical stocks can suffer or decline.
Cyclical Industry Stocks Are Higher-risk Stocks
Certain activities–such as buying a new car or home–are put on hold during tough economic times. Plants make do with their equipment and everyone stays clear of making sizable purchases until the economy starts to improve. Therefore, cyclical industry stocks are considered higher risk stocks when it comes to investing and retirement planning.
Non-cyclical stocks are often called defensive stocks because they present a low investment risk. These stocks cover items that are normally purchased, regardless of the state of the economy. A good example of a non-cyclical stock is a utility company stock – one that provides basic necessities, such as gas, water, or electricity.
Therefore, non-cyclical stocks are not really impacted by economic fluctuations. During an economic downturn, an investor will frequently choose a utility company stock to realize a steady return on their investment. An astute investor knows that a non-cyclical stock does not rely on an economic upturn to realize a gain.
Besides utility companies, other examples of non-cyclical stocks include the following:
- Tobacco companies
- Consumable goods (food, basic toiletries, pharmaceuticals, and cleaning products and materials)
One of the avenues that few investors explore is the purchase of countercyclical stocks. These stocks usually perform the best when the economy is taking a battering. While some investors may debate which stocks fall into this category, most investors will agree that alcohol, discount retailers, or temporary agencies fall under the countercyclical stock class. Some investment specialists have even suggested that correctional facilities be added to a countercyclical stock list. After all, desperate economic times often lead to desperate measures (or crimes), especially when it comes to surviving economically.
Making the Distinction
When you review the differences in cyclical industry stocks and non-cyclical stocks, you can distinguish them by their influence in the economy. A cyclical stock represents items you need while non-cyclical stock represents items that improve your lifestyle, but are not needed to survive economically.
To ensure their portfolios are well-balanced and diversified, investors need to include cyclical stocks, non-cyclical stocks, and countercyclical stocks to their portfolio.
Balancing Out Your Stock Portfolio
Standard and Poors (S&P) categorizes stocks into 10 sectors. Two sectors, Utilities and Consumer (Staples), are the non-cyclical stocks on the list. These stocks should be strongly considered if you are a conservative investor and want to realize a continued return on your investment, regardless of the current economic cycle. Below are the S&P classifications. Each classification is defined as an industry cyclical stock with the exception, again, of Consumer (Staples) and Utilities.
- Consumer (Discretionary)
- Consumer (Staples)
- Health Care
- IT (Information Technology)
- Telecommunications (Services)
Three of the listed S&P sectors have outperformed the S&P in the last 10 years (as of 2020), and therefore are considered long-term winning bets when making stock market investments. These are the best sectors to choose for beating the stock market in the long run. The sectors include Health Care, Information Technology (IT), and Consumer (Discretionary).
Because of an aging population and advances in biotechnology, the health care sector will continue to prosper. Because this sector is broad, stocks related to this category include medical facility conglomerates, health institutional services, insurance companies, biomedical businesses, medical instrument manufacturers, and pharmaceutical companies.
Even in a weak economy, the health care industry continues to perform fairly well because people still get sick and need to see a doctor. Therefore, health care stocks are more defensive than offensive, when it comes to making money.
Sitting in the center of Big Data, IT stocks continue to do well, given the rapid advancements in technology. As of 2020, these stocks still continue to shape the economy. In addition, stock forecasters do not see this trend slowing down anytime too soon.
Some of the stocks in this sector include manufacturers of computer hardware or computer software, or companies providing computer services and business data processing. Some examples of IT stocks and companies include Apple (AAPL), Google (GOOG), and Facebook (FB).
While Consumer (Discretionary) stocks are considered cyclical and do well when the economy is healthier, they still are the stocks to choose to beat the market in the long run. Include these stocks in a well-balanced stock portfolio. Good stocks to choose, under this category, include Starbucks (SBUX), Apple (AAPL), and Disney (DIS).
Creating a Diverse Portfolio
A diverse and winning stock portfolio should include an array of stock picks. To play it safe, add Utility Stocks, Consumer (Staples), Consumer (Discretionary), Health Care, and IT. That way, you can make some regular and long-term gains more securely. All these stocks are good to hold onto even in a sluggish economy.
What Do You Think?
So, what do you think? What are your favorite stocks and why? Which stocks, do you think, are the best ones to pick, for long-term future gains? Do you like buying stocks, or do you have a preferred mutual fund? Of the S&P classifications, which ones do you like and why?