What Are Cyclical Stocks & How Do They Work?

Some investors want stocks that tend to remain stable and reliable even in an economic downturn. But others want the chance for big returns, and they’re willing to risk losses for that opportunity. That’s the difference between what are known as cyclical and non-cyclical stocks.

What are cyclical stocks?

Cyclical stocks are shares of companies whose performance tends to follow the ups and downs of the economy: They typically rise when the economy is expanding, with high employment rates and consumer spending, and they tend to fall in times of recession or contraction.

Cyclical stocks vs. non-cyclical stocks

Cyclical stocks are tied to economic performance because they’re generally shares of companies that sell goods or services that are discretionary, such as travel, entertainment, and restaurants. Because these cyclical sectors aren’t usually providing necessities, consumers are more apt to spend on these when economic times are good and pull back when things are tight. Examples of cyclical stocks include Starbucks, Delta Air Lines, Disney, and Apple.

Non-cyclical stocks are the opposite: They’re also called defensive stocks because consumers continue to spend on these categories even during economic downturns. Many non-cyclical stocks are tied to goods and services such as health care, water, gas, and groceries.

No stock is recession-proof, but the difference is these companies aren’t as affected by economic swings as cyclical stocks. Though they generally may not have as much potential upside, these non-cyclicals are generally considered to be a safer place for investors to plunk down cash and ride out a downturn. These defensive stocks include General Electric, Costco, Johnson & Johnson, and NextEra Energy.

Which industries have cyclical stocks?

Several industries should be on a list of cyclical stocks. Here are a few of the most notable:

• Discretionary retail.

  These are the purchases that consumers could choose to hold off buying when they’re belt-tightening. Discretionary retail items include jewelry, makeup, and high-end clothing.

• Travel.

  Both leisure and business travel flourish in flush times and are scaled back in downturns. This category includes airlines, hotels, and booking/travel agencies.

• Restaurants.

  This sector tends to hurt in an economic downturn, as eating out can get pricey and more consumers opt to cook at home when money is tight.

• Consumer technology.

  Modern life is increasingly online, both at work and at home. But in a recession, people and businesses may hang onto existing devices rather than upgrade to the latest and greatest. Most, though not all, tech stocks are cyclical.

• Cars.

  Cars are much like consumer tech: When consumers feel comfortable spending, they have fewer qualms about buying or leasing a new (or new-to-you) car. In a downturn, they’re likely to stick with what’s already in the garage.

• Entertainment.

  This is the sector people spend on when they want to kick back and relax: concerts, streaming video services, music subscriptions, and movie tickets. They’re often some of the first items to go when people are on a budget.

• Appliances and furniture.

  These are durable, long-lasting goods that people don’t replace often—items such as washers, refrigerators, and furniture. Like electronic devices and cars, consumers often delay upgrading these goods in a downturn.

• Manufacturing.

  This sector is affected by the boom or bust in the categories above. When people are spending on physical goods, factories stay humming. When demand wanes, so does manufacturing.‍

• Banks.

  In good economic times, demand for mortgage and car loans is high. In a downturn, not only does demand fall, but more consumers are likely to have trouble paying existing loans and credit cards. Bank earnings are also sensitive to changes in interest rates, which typically fall before and during a recession, cutting into lenders’ profit margins.

Identifying cyclical stocks

The standard method to identify a cyclical stock is to examine the so-called beta value, also called the beta coefficient. This number tells investors how sensitive a specific stock is to movements in the broader market; it’s calculated by comparing the stock’s returns relative to the market as a whole.

A beta value of one indicates a stock that moves in lockstep with the market, while a value higher than one denotes that the stock is more volatile, and a figure below one means shares move less than the broader market. So, most cyclical stocks have a beta value higher than one.

Investors can also look at trends in a stock’s earnings per share (EPS). The EPS of cyclical stocks tend to fluctuate, rising and falling with the overall economic sentiment.

A third figure relevant to value cyclical stocks is the price-to-earnings ratio (P/E), which measures a stock’s price in relation to its (EPS). Cyclical stocks usually have P/E ratios that are lower, so they tend to be cheaper when compared to most non-cyclicals.

Advantages and disadvantages of investing in cyclical stocks

Investing in cyclical stocks comes with both benefits and risks. Those opposing forces often are intertwined.

Volatility

Cyclical stocks can be particularly volatile, with prices moving higher or lower depending on the broader market and other external factors. On one hand, that means there’s a chance for significant gains and profit that beats the overall market, especially when compared to more stable defensive stocks. On the other hand, cyclicals can also drop sharply when the economic picture is bleaker.

Some investors try to time purchases and sales based on the economic cycle, though as a rule of thumb this is difficult to get right: Rising or falling markets can fall or rise still more. And market sentiment, as the COVID crisis shows, sometimes can change almost overnight.

Cheap in a downturn

Cyclical stocks’ decline in a recession is bad news for investors who bought high. For other investors, it can offer a buying opportunity.

Diversification

Defensive stocks tend to be reliable performers that are less subject to unpredictable external factors. That steadiness is welcome during a downturn. But the limited downside usually means there’s also a limited upside. A mix of cyclical and non-cyclical stocks in a portfolio is one way investors try to balance stability and risk.  

The bottom line

Cyclical stocks typically follow the broader economy, gaining when times are good and declining in a downturn. They’re generally companies that deal in discretionary spending like entertainment and travel, which consumers often scale back during an economic slowdown. Non-cyclical, or defensive, stocks generally are more stable throughout the economic cycle.

Both categories have advantages and disadvantages: Cyclical stocks tend to be riskier investments than defensive stocks, but they also offer the potential for bigger gains. Non-cyclicals are steadier, even in tough economic times, yet that stability comes with lower chances for big returns. Investors usually hold a mix of both in a diversified portfolio.