Understanding cyclical versus non-cyclical stocks

Pranati Deva
Updated: 14 Dec 2021, 03:26 PM IST
TL;DR.

A well-balanced portfolio should consider a mix of both cyclical and non-cyclical stocks. Let’s better understand these and take a look at which sectors are cyclical and vice versa.

A well-balanced portfolio should consider a mix of both cyclical and non-cyclical stocks.

A well-balanced portfolio should consider a mix of both cyclical and non-cyclical stocks.

A well-balanced portfolio requires a mix of assets from various sectors and market capitalisations. Another such classification is based on the economy. Stocks that rise when the economy is growing and fall when it's in recession. These stocks are called cyclical stocks. Meanwhile, there are some stocks that continue to outperform despite economic fluctuations, such stocks are called non-cyclical stocks.

Let's properly understand these two categories:

Cyclical

These companies are directly affected by the economy. When the economy is booming, these stocks also move in a positive direction. While, when the economy is contracting, they move in a negative direction.

For instance, in the case of a booming economy, people spend more on automobiles, real estate, travel, etc. The demand for such things goes away during a recession leading to a decrease in revenue for such firms and hence a fall in their stock prices.

These follow the various cycles of an economy like expansion, recession, recovery. Expansion is when economic activities are rising, leading to people buying more products and services. A recession is when the activity is on a decline while recovery is when the economic activity has slowly started after a recession.

However, one must note that such stocks have higher risk as any volatility or fluctuations lead to major swings. While the upside is more in the case of a rising economy, the downside can also be steeper in the case of a recession.

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Cyclical vs non-cyclical

A well-balanced portfolio requires a mix of assets from various sectors and market capitalisations. Another such classification is based on the economy. Stocks that rise when the economy is growing and fall when it's in recession. These stocks are called cyclical stocks. Meanwhile, there are some stocks that continue to outperform despite economic fluctuations, such stocks are called non-cyclical stocks.

Let's properly understand these two categories:

Cyclical

These companies are directly affected by the economy. When the economy is booming, these stocks also move in a positive direction. While, when the economy is contracting, they move in a negative direction.

For instance, in the case of a booming economy, people spend more on automobiles, real estate, travel, etc. The demand for such things goes away during a recession leading to a decrease in revenue for such firms and hence a fall in their stock prices.

These follow the various cycles of an economy like expansion, recession, recovery. Expansion is when economic activities are rising, leading to people buying more products and services. A recession is when the activity is on a decline while recovery is when the economic activity has slowly started after a recession.

However, one must note that such stocks have higher risk as any volatility or fluctuations lead to major swings. While the upside is more in the case of a rising economy, the downside can also be steeper in the case of a recession.

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Non-Cyclical

These are stocks that outperform the markets whether the economy is rising or contracting. Good and services that are necessary in times good and bad come under this category.

Such stocks are less affected by the volatility in equity markets and provide stable returns irrespective of how the overall markets or economy are performing. They are from well-established companies whose products are always in demand throughout the year regardless of the economy or market trends like healthcare, consumer staples and utilities.

Like toothpaste, eatables, or medicine, even if the economy is falling, these are everyday items that people cannot do away with. However, when the economy is rising, their demand improves.

These are safer than cyclical stocks since the volatility in such stocks is comparatively less. Risk-averse investors generally prefer such stocks more. However, since the decline is limited, so can be the growth.

While cyclical stocks are more correlated to the market mood, non-cyclical stocks give stable returns even in volatile and fluctuating spells of the market. However, even though cyclical stocks have a higher risk factor, in pleasant conditions they are high reward stocks as well, meanwhile, non-cyclical stocks generally give consistent returns but with limited growth potential.

Now that we know how they differ, it is important to balance your portfolio with stocks from both categories. An investor can use both the stock to his/her advantage depending on the market and economic trends.

First Published: 14 Dec 2021, 03:26 PM IST
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