Consumer Cyclical

Consumer cyclicals are stocks of companies producing non-essential commodities. Their performance is directly related to any changes in the economy. Investing in cyclical stocks during an economic upturn may yield promising returns to investors. 

Also called “consumer discretionary,” it encompasses businesses that sell dispensable goods and services like designer clothing, automobile, eateries, and entertainment. The stocks of such companies are referred to as cyclical stocks. This is because their movement is usually synchronized with the market. Thus, the risks and benefits of investing in them depend on the investment timing.

Key Takeaways                                                               

• Consumer cyclical is a category of stocks whose performance is sensitive to the economic cycle, increasing when it boosts and decreasing during a downturn. 
• It usually represents stocks of companies selling non-essential products or services like entertainment, high-end gadgets, sports cars, and expensive clothing. 
• Investment in cyclical stocks ensures maximum profitability during an economic upturn and portfolio diversification. 
• It contrasts with “consumer staples,” including basic commodities like food and medicine, which remain unaffected by market shifts.

The term consumer cyclical denotes stocks of companies that offer products that are affected by economic cycles. Cyclicals flourish when the market is up, and consumers have more spending potential. Nevertheless, it declines when the market is down, and consumers have less spending potential. So, let’s see how it works.

A growing economy results in higher disposable income with its people, enhancing their buying power. People with rising income are more likely to buy a fancy car, eat out at an expensive restaurant, or take a vacation. This translates into profit for companies offering such goods and services, reflected in their rising stock price.

Conversely, when an economy takes a downturn, demand for these items recedes, reducing the earnings and stock prices of companies producing them. However, people are not likely to curtail their spending on food and medicines even during a slowdown as they are essential for their survival. Such essential commodities are called non-cyclical or consumer staples. They remain unaffected by market changes and enjoy an inelastic demand.

Unlike staples, cyclicals suffer a maximum loss during an economic recession. This is because people prefer to spend money on consumer staples rather than investing in non-essential items. As a result, the prices of cyclical stocks nosedive.

The economic downturn due to the COVID 19 pandemic resulted in several cyclical stocks being affected. One such stock is of global fast-food retailer McDonald's. With people staying at home and spending on consumer staples during the pandemic, the company's fortunes took a beating.

The pandemic-imposed restrictions and economic recession led to a fall in its revenue from $21.4 billion in 2019 to $19.2 billion in 2020. As a result, stock prices declined from $186 in December 2020 to $140 in March 2020.

However, with the pandemic receding and economic upturn, the company is seeing a revival in its revenue. The company's earnings have witnessed positive growth and are likely to ride high in the coming months.

A recent Forbes article discusses the ten best consumer cyclical stocks as of March 2022. It also mentions four sub-sectors of consumer cyclical stocks: retailers, automobile and automobile parts, durable household items, and hotels, restaurants, & entertainment.

Here is the list.

Cyclical stocks provide the highest gains in a bull market and endure the biggest losses in a bear market. This is because it comprises stocks of industries that are highly dependent upon consumer demand for business sustenance and growth. Consequently, their prices surge in a booming economy and fall when it slows down.

Since cyclical stocks move in tandem with the markets, their performance is based on market timing. Therefore, investors must know how to trade cyclical stocks at the right time to obtain the utmost benefits. Nonetheless, it is tough to interpret the right market timing due to an unexpected rebound in certain cyclical before the end of the downturn.

Hence, investors must target cyclical stocks with high dividends

to diminish the possible drawbacks. The best time to buy cyclical stocks is when they possess high valuation ratios. With perfect investment timing, the volatile consumer cyclical sector provides impressive growth potential. Needlessly, cyclical stocks are suitable for experienced investors with professional insight.

Investors may purchase cyclical stocks via individual stock investments in companies like Adidas, Amazon, Tesla, McDonald's, etc. To reduce risk and diversify investment in consumer cyclicals, investors can choose exchange-traded funds (ETFs) or index funds. Also, they can choose any of the accessible consumer discretionary ETFs.

Moreover, a judicious mix of both cyclical and non-cyclical stocks leads to sustained long-term returns with minimum risk. 

The investor must buy cyclical stocks when the economy is growing. This growth happens when:

• Metals witness the beginning of a supercycle
• Government pushes its capital investment cycle
• Frenzied business expansion occurs
• A significant external investment happens in the economy

Investment in cyclical stocks aids in:

• Ensuring excellent performance in a thriving economy
• Portfolio diversification

Investment in cyclical stocks requires thorough financial knowledge with a backup plan to limit the damage caused by a possible economic slump.