Cyclical stocks often mirror the performance of the broader economy. Historically, these shares have prospered during economic highs but have faced devaluations during downturns.
However, in the last three months, cyclical stocks helped power a major rally in the US.
In this article:
- Cyclical shares explained
- Spotting a Cyclical Stock
- Investment considerations
Despite the numbers, the bank says it is time for investors to move away from buying cyclical shares – those that closely track the health of an economy such as car makers.
These stocks have outperformed defensives by 16% since early May, rising 18%.
Note, defensive stocks are those that refer to companies that make or sell in-demand products regardless of economic growth, such as pharmaceuticals, healthcare and consumer staples. These are companies whose products are consistently in demand, ensuring stability in profits and share prices.
Goldman portfolio strategist Lily Calcagnini said: “We believe the bulk of this cyclical rally is behind us. Economic growth is the key driver of cyclical outperformance, but our economists forecast that growth will decelerate to 1% quarter-over-quarter annualised in the September and December quarters this year.”
Calcagnini cited historical precedence for that assumption.
“Following 27 sharp cyclical rallies similar to the one that occurred from May to June, cyclical stocks achieved less than 1% incremental upside during the next 12 months in the median experience since 1973,” she said.
Calcagnini said the forward path of economic growth would determine whether cyclicals had more room to run.
Cyclical shares explained
Cyclical shares represent companies highly influenced by macroeconomic changes. As the economy experiences its natural ebb and flow of expansion and contraction, cyclical shares typically react in tandem. When the economy prospers, cyclical shares tend to outpace others. Conversely, when economic times are tough, they lag behind.
Cyclical shares might see a dip in value during economic recessions but can witness significant gains during expansionary periods. Companies in this category often deal in discretionary items such as luxury goods, electronics or holidays. Consumer spending on these items rises with better economic conditions and shrinks during downturns.
Travel companies such as Flight Centre (ASX:FLT) Travel Group Ltd and Qantas Airways (ASX:QAN) Ltd are classic cyclical stocks as are electronics retailers including JB Hi-Fi Ltd, which showcase cyclical patterns, as evidenced by their swift recoveries post the initial pandemic shock in 2020, only to face sell-offs in 2022 due to changing economic factors.
Spotting a cyclical stock
Understanding your own spending habits can help identify cyclical stocks. Essential purchases, like food and utilities, are constants. Discretionary items, which vary based on income and economic health, fall under the cyclical category.
Companies trading these products or services often see their fortunes fluctuate with the broader economy, which generally goes through four economic cycles.
Investors often attempt to time the market, buying cyclical stocks when the economy is low and selling at its peak. Yet, predicting economic stages is challenging. To navigate this, a balanced portfolio combining cyclical and defensive stocks is generally recommended.
Uncertainty in economic forecasts can introduce market volatility. Given their inherent tie to economic health, cyclical shares can exhibit extreme price fluctuations with changing economic perspectives, leading to higher portfolio volatility.
Investors considering cyclical stocks must weigh potential highs against downturn risks, aligning choices with their risk appetite and investment goals.