Understanding Cyclical and Non-Cyclical Stocks for Better Portfolio Diversification

Cyclical stocks fluctuate with economic trends, while non-cyclical stocks remain stable. Understanding these categories helps investors diversify portfolios and navigate market conditions effectively.

In order to achieve their goals, investors need to have a balanced portfolio. This entails giving careful consideration to the selection of stocks. There are many ways to understand which stocks to purchase; one such way is by looking at the fundamental nature of the business to further classify them into cyclical and non-cyclical stocks. In this article, we will understand what exactly cyclical and non-cyclical stocks are so that you can make informed decisions to efficiently diversify your portfolio.   

A cyclical stock is the one that is more likely to move in the direction of the general market. If the economy is increasing, the prices of these stocks would increase. In contrast, when the market goes down, so do the prices of these stocks. Companies that are cyclical are the ones that are prone to various economic fluctuations and have a high correlation to economic movements. Investors usually buy these stocks when the market is down and sell in the event of an upward market trend. However, to do this, an investor must be able to predict the market trends i.e. both the upswing and downswing to effectively take advantage of the situation. Below are the several areas of business that fall into the category of cyclical stocks: 

1. Airlines – The airlines are often amongst the hardest hit in terms of revenue declines due to an economic downturn. In good economic times, people have more disposable income, so they are more willing to take vacations and make use of air travel. Conversely, during bad economic times, people are much more cautious about spending. As a result, they tend to take more fiscally conservative vacations closer to home (if they go at all) and avoid expensive air travel.  

2. Hotels – Much like airlines, the revenue of hotels go hand in hand with the level of tourist activity taking place in a country. With less travel taking place during an economic downturn and more travel happening during the times of economic expansion, hotel revenues tend to follow economic cycles as well.  

3. Car manufacturers - A new car is usually a big expense for an average individual. In times of economic recessions, such big financial decisions take the back seat but end up high on the priority list when economic times are good.  

4. Furniture retailers - Furniture is a relatively large expense. Following along the lines of vehicle purchases, new furniture purchases are the most common during positive economic cycles.  

A non-cyclical stock (also known as defensive stock) is the one that is not largely affected by the economic condition prevailing in the country. These companies are more immune to market fluctuations. For instance, food producers and pharmaceutical companies offer products that are essential to the end-user and the purchases of such products cannot be deferred to a later date. This is quite logical since people always need food, medicine, regardless of the economic situation. Non-cyclical stocks repeatedly outperform the market when economic growth slows because, unlike cyclical stocks, they do not crash with the market. Below are several areas of business that fall into the category of non-cyclical stocks.  

1. Defence – There is always a need for military defence and thus, in line with this, countries around the world allocate a significant portion of their budget for the best in defence technology. Hence, such companies are shielded from economic downturns to a large extent.   

2. Pharmaceuticals - Medicines are essential for human wellbeing and survival. Thus, large biotechnology companies will see revenue growth even during economic downturns.  

3. 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 utility sector.  

4. Non-cyclical consumer goods - Most consumer goods fall into the cyclical category. However, cleaning supplies, toothpaste, and other consumer goods is also considered essential. Companies that supply the overwhelming demand for these types of products will see revenue growth, regardless of the economic conditions.