Cyclicality

How to get the best returns in good times and reduce your losses in the bad times.

What is cyclicality?

Not all sectors have the same risk. Some sectors do a lot better than average when the economy is doing well, but a lot worse than average when the economy is doing poorly.

These are risky as the stock performance is quite unpredictable. We call these cyclical stocks.

Some sectors are a lot less risky. They always performe in a mediocre manner. This means that if the economy is performing well, then the stocks tend to rise slightly, and if the economy is underperforming these stocks will go down slightly — We call these non-cyclical stocks.

Why Are Some Stocks Cyclical And Some Are Not?

A stock is cyclical when you are much more likely to buy its products when the economy is doing well. When the economy is doing well, you are more likely to have a job, are getting paid well and are optimistic about the future. Because of this, the average person might be willing to spend in cyclical services like flight tickets and purchasing boats. Airlines and boat manufacturers are thus cyclical.

When the economy is doing badly, these types of expenses for customers will be the first for them to cut out to save money, as they are not necessary.Therefore, these stocks will suffer a lot.

Non-cyclical stocks, on the other hand, notice similar levels of sales no matter the economic condition. For example, even if the economy is doing badly, you still need groceries and a house to live. When the economy is doing well, on the other hand, you aren’t really going to buy that much more food or space to live. For this reason, supermarkets and real estate companies are lower risk: non-cyclical.

A stock is cyclical when you are much more likely to buy its products when the economy is doing well. When the economy is doing well, you are more likely to have a job, are getting paid well and are optimistic about the future.

Non-cyclical stocks, on the other hand, notice similar levels of sales no matter the economic condition.

How Do We Measure Cyclicality?

The primary measure used is called Beta. The higher the Beta, the riskier the stock. A beta of 1 implies a risk equivalent to the average stock, meaning if the stock market on average goes up by 10%, your stock should also go up by 10%. Likewise if it goes down 5%.

A beta of 1.5 means the stock is riskier than the average stock. This means that if the average stock in the economy goes up 10%, your stock will go up 15%. If the stock market goes down 5%, your stock will go down 7.5%.

• A beta over 1 is typical for airlines and boat manufacturers.

A beta of 0.5 means the stock is less risky compared to the average stock. This means that if the average stock in the economy goes up 10%, your stock will go up 5%. If the stock market goes down 5%, your stock will go down 2.5%.

• A beta below 1 is typical for real estate and supermarket stocks.

The primary measure used is called Beta. The higher the Beta, the riskier the stock!

Conclusion

Do I Choose Cyclical Or Non-Cyclical stocks?

The ideal scenario is owning non-cyclical stocks when the stock market overall is doing badly, as your stocks will go down less than the average stock, but then switch over to cyclical stocks when stocks are doing well because your stock will go up more than the average stock. In practice, this is difficult to time.

Something more reasonable would be to have a portfolio of both cyclical and non-cyclical stocks, and then, when you are reasonably sure that a period of economic suffering is likely, buy a bit extra non-cyclical stocks.

When there’s a very good chance of economic recovery and sustained economic growth, it’s time to buy extra cyclical stocks.