As you begin to invest, you’ll learn that there are several ways to classify stocks. For example, tech stocks, biotech stocks, service stocks, and basic materials stocks are sector classifications.
Stocks can also be classified by market capitalization. This type of classification includes the use of terms like micro cap, small cap, mid cap, and large cap. The term penny stocks is also used as a way to classify stocks with relatively low market capitalization.
Then, you have less common classifications that you learn about as you go. One of these is known as cyclical classification. Cyclical classification is more binary than other ways to group stocks. Either a stock is cyclical or it’s not; there’s not much room in between.
Although cyclical classification is lesser-known, you shouldn’t discount the clarity it offers.
What Are Cyclical Stocks?
Cyclical stocks are heavily correlated with economic cycles.
When economic performance is positive, these stocks tend to move in a positive direction. When it’s negative, they move in a negative direction.
There are four key economic cycles to watch for when considering investments in cyclical stocks:
- Expansion. Economic expansion is a period in which economic activity is on the rise, leading to increased access to products and services for consumers.
- Peak. An economic peak refers to the highest point in economic activity following an economic expansion and preceding an economic recession.
- Recession. An economic recession is a decline in economic activity following an economic peak.
- Recovery. An economic recovery is a period of time in which economic activity begins to reverse directions and recover from an economic recession.
Due to the high correlation — whether direct or inverse — between cyclical stocks and these economic cycles, it’s important to keep a close eye on market conditions to get an idea of when to enter and exit positions in these investment vehicles.
Examples of Cyclical Stocks
Because most cyclical stocks tend to move in the same direction of the economy, there are several areas of business that fall into this category. Some of the most well-known include:
- Airlines. During times of economic hardship, consumers are less likely to travel. Airlines are often among the hardest hit in terms of revenue declines as a result of this phenomenon. Conversely, when economic conditions are positive, we see more traveling among consumers, leading to stronger revenue and growth in airline stocks.
- Car Manufacturers. A new car is a massive expense. For most Americans, it’s the second-largest expense they will ever have, second only to their home. Large financial decisions tend to take the back seat during economic recessions, but end up high on the priority list when economic times are good.
- Clothing Stores. Clothing is both a commodity and a comfort. Everyone needs clothing, but consumers tend to buy new clothing more when economic conditions are positive and become more thrifty when times are tough, leading to revenue trends for clothing stores that follow economic cycles.
- Furniture Retailers. Furniture is a relatively large expense. Following along the lines of vehicle purchases, new furniture purchases are most common during positive economic cycles.
- Hotels. With less travel taking place during an economic downturn and more travel taking place during times of economic expansion, hotel revenues tend to follow economic cycles as well.
- Restaurants. When consumers have less money to spend or need to focus on savings due to economic hardship, they tend to eat at home more. Eating at restaurants is a more expensive option and small luxury that leads the way during economic expansion.
- Gold Miners. There are several cyclical stocks that have an inverse correlation with economic developments — gold miners are a great example of this. During economic recessions, gold’s price tends to rise as investors look for safe havens. During economic expansions, the price of gold will decline as safe-haven investments take second place to more aggressive investment options.
Pro tip: You can earn a free share of stock (up to $200 value) when you open a new trading account from Robinhood. With Robinhood, you can customize your portfolio with stocks and ETFs, plus you can invest in fractional shares.
What Are Noncyclical Stocks?
Noncyclical stocks, sometimes called defensive stocks, are the cyclical stocks’ opposite. Stocks in the noncyclical category follow steady trends of growth and aren’t impacted much by economic cycles.
These stocks have some form of economic shield in place that allows them to hold value during economic recessions, and they also provide products and services that fill a need during economic expansions.
As a result, economic cycles have little to no bearing on the price movement of these stocks.
Examples of Noncyclical Stocks
As with cyclical stocks, there are several areas of business that are represented by noncyclical stocks. Some of the most common include:
- Defense. Unfortunately, there will always be a need for military defense. As long as geopolitical tensions live on, governments around the world will always be willing to pay top dollar for the best in defense technology, shielding defense companies from economic downturns as well as providing a point of value during expansions.
- Pharmaceuticals. Regardless of economic conditions, when you get sick, you will go to the doctor, purchase medicine, and consider other medical services. As such, strong biotechnology companies will see revenue growth even during economic downturns.
- Utilities. Electricity, natural gas, clean water, and sewage services are the basics of consumer needs in developed nations. As such, whether economic times are good or bad, revenue growth stays relatively consistent within the utilities sector.
- Noncyclical Consumer Goods. Most consumer goods fall into the cyclical category. However, toilet paper, cleaning supplies, toothpaste, and other consumer goods are absolutely essential. Companies that supply the overwhelming demand for these types of products will see revenue growth regardless of economic conditions.
Cyclical Stock Pros and Cons
As with any other class of stocks, there are benefits and drawbacks to making investments in cyclical stocks. Here are some of the most important to consider.
Cyclical Stock Pros
Investing in cyclical stocks comes with quite a few benefits. Some of the most important include:
1. They’re Easy to Read
Because cyclical stocks tend to ebb and flow with economic conditions, these stocks are fairly easy to read. As a result, they’re a great choice for beginner investors.
2. They Can See Big Movements From High Volatility
Market volatility refers to the rate at which stocks move up and down. Highly volatile stocks make dramatic moves up and down while low-volatility stocks remain relatively stable.
As a result, timing the purchase and sale of high-volatility stocks properly has the potential to yield much larger gains than investments made in low-volatility stocks.
Cyclical stocks tend to experience high levels of volatility, opening the door to potentially large profits.
3. They Offer Easy Diversification
There are cyclical stocks spread across a wide range of sectors and market caps. As a result, it’s quite easy to have a heavily diversified portfolio that consists of a large percentage of cyclical stocks.
Given that diversification is a big key to success in the stock market, the fact that cyclical stocks represent a diverse group of companies gives you an opportunity to diversify clearly while investing in a heavily cyclical strategy, protecting your value in the long run.
Cyclical Stock Cons
No company or stock is perfect. As is the case with any other classification of stocks, there are some drawbacks to investing in cyclical stocks.
1. You Have to Keep Your Finger on the Pulse
Although cyclical stocks are relatively easy to read, taking the time to read the market is critically important.
Economic developments happen on a daily basis. So, investors in cyclical stocks must have a willingness to pay attention to the news in order to determine good entry and exit points.
If you don’t, an economic recession could take place before you know it, leading to significant losses.
2. Cyclical Stocks Are Not Consistent Gainers
By their nature, cyclical stocks move up and down with economic cycles. As such, if you’re looking for an investment opportunity that has slow, steady returns to look forward to, you’ll need to look at noncyclical stocks.
3. Volatility Is a Double-Edged Sword
It’s true that the highly volatile nature of cyclical stocks can lead to tremendous gains. However, volatility isn’t always your friend.
High-volatility stocks can fall just as fast as they climb. As a result, your potential to generate significant gains is matched by the real possibility of significant losses.
Pro tip: Before you add any investments to your portfolio, make sure you’re choosing the best possible companies. Stock screeners like Stock Rover can help you narrow down the choices to companies that meet your individual requirements. Learn more about our favorite stock screeners.
Noncyclical Stock Pros and Cons
Living on the opposite pole as cyclical stocks, noncyclical stocks also have their own set of benefits and drawbacks to speak of.
Noncyclical Stock Pros
There are several reasons that many investors flock to noncyclical stocks. Some of the most pressing include:
1. They Tend to Offer Stable Growth
Cyclical stocks represent companies with products and services that consumers simply can’t live without.
As a result, as the population of consumers grows, so too do these companies, resulting in relatively stable growth for investors to look forward to over the long term.
2. They Pay Dividends
Noncyclical stocks benefit from a consistent flow of revenue that’s relatively easy to predict. Moreover, these companies have a keen ability to predict the cost of infrastructure maintenance and growth.
3. They Have Safe-Haven Qualities
The foundation of noncyclical stocks is the fact that they do not succumb to declines in economic activity. As a result, they’re a highly popular option among investors looking for safe-haven qualities in the investments they make.
Noncyclical Stock Cons
Noncyclical stocks are great to have as a piece of your investment portfolio, but it’s not all peaches and cream here. There are some drawbacks to investing in stocks that don’t have a cyclical nature.
1. They Have Less Potential
Investments that are considered safe options are a give and take.
Slow and steady growth means that the potential for dramatic gains over a short period of time is diminished. With smaller risk often comes smaller potential reward, and that generally proves true when investing in noncyclical stocks.
2. Safe Isn’t Always Safe
Investors often pour money into noncyclical stocks under the assumption that it’s impossible to lose money in the space. That’s not the case.
Every investment comes with the potential for losses, and any belief that this isn’t the case is a dangerous belief.
When to Invest in Cyclical Stocks
Both cyclical and noncyclical stocks have a place and time in any investment portfolio. When it comes to investments in cyclical stocks, the best time to make an investment is early in an economic recovery.
The goal here is to catch the market at the bottom of an economic recession and make money while you ride the wave through the recovery and expansion cycles.
As economic growth peaks, it’s time to sell your positions in cyclical stocks and look for safer investment options in order to avoid the significant losses that are likely to follow.
Keep in mind, this is the case when investing in cyclical stocks with positive correlations to the economy.
Cyclical stocks like gold miners that tend to move in the opposite direction of economic conditions should be invested in at the same time as noncyclical stocks: when you think the economy has peaked.
When to Invest in Noncyclical Stocks
Noncyclical stocks are on the other end of the stock market.
When an economic recovery or expansion is taking place, the opportunity cost associated with investing in noncyclical stocks makes investments in the space not worth it.
On the other hand, when you believe that economic growth is at its peak, it’s time to double down on noncyclical plays. When economic conditions falter, these stocks will stay relatively stable.
At the same time, owning them through a recession offers potential dividends that further shield your portfolio from significant losses.
How to Track Economic Conditions
When deciding to invest in cyclical or noncyclical stocks, economic conditions will play a huge role, but most people aren’t economists. So, how does the average investor go about assessing economic conditions?
There are a few things that you can do to make an educated decision with regard to future economic conditions.
Pay Close Attention to the News
Geopolitical conditions, presidential and congressional elections, and several other factors that you’ll find by watching the news will give you clues as to where the economy is headed.
By simply watching the news every morning or every night, you will become more informed with regard to economic developments.
Watch Job Growth Reports
There are two weekly reports that give you an idea of what’s going on with jobs in the United States.
The first is the Bureau of Labor Statistics Weekly Report. The other is the Unemployment Insurance Weekly Claims Report. These reports provide detailed information on jobs growth in the United States.
When economic conditions are positive, consistent job growth is seen. Conversely, under negative economic conditions, job growth stalls or reverses and unemployment rises.
Follow GDP Reports
Gross domestic product (GDP) is a monetary value representing all of the products and services produced in the United States.
As the figure rises, it represents a growing economy. Conversely, when GDP growth stalls or reverses, an economic recession is likely ahead.
Keep an Eye on Oil
Oil is an important commodity. Consumers and businesses use it to power everything from the vehicles they drive to the homes and offices they occupy.
When oil falls in value, it could be an indication that businesses and consumers are looking for ways to save money, suggesting that an economic recession is on the horizon.
Follow Gold and Silver
Gold and silver are classic safe-haven investments.
When the investing community believes that stocks are going to fall in value, they pull money out of the stock market and use those funds to stockpile gold and silver in hopes that these precious metals will either maintain or grow in value through an economic recession.
If the values of precious metals like gold and silver are falling, it’s a strong indication that economic conditions are positive. Conversely, if gold and silver prices are rising, the economy could be headed for a recession.
Although the terms cyclical and noncyclical are often unknown to new investors, they are important tools for a successful investor’s toolbox. By reading what economic conditions are telling you, you’re able to make more educated investment decisions.
Because investing isn’t gambling, but rather a calculated placement of money in a vehicle that’s expected to grow, educated decisions are more commonly profitable than blind guesses.
By paying attention to the economy and making the decision to move toward cyclical stocks when economic conditions are on the rise and noncyclical stocks when they are faltering, you have the ability to greatly expand your potential earnings in the market.