The Pros and Cons of Cyclical Stock Investing

Have you ever asked yourself about what an ideal portfolio should look like? Of course, the definition of that elusive term is different for every investor. But many people agree that a well-rounded, diversified set of holdings should include at least some cyclical stocks. These are the shares of companies that tend to trend in tandem with the economy. When economic times are good, the cyclical stocks do well. When a recession hits, they fare poorly. It’s important to learn more on market cycle pros and cons in order to build a healthy portfolio. Like most other kinds of investments, there are pros and cons to investing in companies whose fortunes match those of the general economy. Here are the most pertinent facts for anyone who is interested in maximizing returns for short-term and long-term results.

Pro: Growth

When the economy is hot, it’s wise to have these kinds of stocks in your portfolio. Yes, they will rise in price while things continue to heat up. But, for active investors, that’s part of the excitement of shares that follow macroeconomic cycles. The advantage is that it’s easy to identify the companies in this niche because they tend to sell discretionary services and goods. Those are the things that people buy when they have extra, discretionary, money on hand. What are they? Companies in this sector include hotel chains, automakers, restaurants, airlines, casinos/gaming establishments, hotels, and similar entities. One of the most common strategies is to buy in at the lowest point of a recession, with the hope that your shares will rise in value when the situation improves.

Con: Inappropriate for Long-Term Portfolios

See growth above and you’ll instantly get the gist of this point. Those who prefer a set it and forget it approach to building wealth and acquiring corporate ownership shares typically avoid adding cycle-based companies to their holdings. The technique of buying in the depth of a recession and waiting for the economy to shift back into gear can take years. If you’re over the age of 45, for example, it could be poisonous to hold such volatile assets, because it can take a decade or more for a recession to fully turn around. Anyone who lived through the 1980s and early 2000s learned that lesson the hard way. This is perhaps the main disadvantage of owning cycle-based companies in a long-term portfolio. The expected recovery might not arrive in time for your retirement.

Pro: Interest Rate Sensitivity

If you hold cycled assets while the general interest rates are falling, you’re in a very good position to pocket a nice profit. That’s because corporations typically benefit from lower rates. They can borrow more at a low cost, expand operations, hire more workers, and do all sorts of things that produce higher prices for shareholders. Some investors are inveterate interest rate watchers, and keep a close eye on the ups and downs of every component of the economy’s cost of borrowing. For people like that, discretionary ownership can be a big plus. As long as they’re able to identify significant rate declines in advance, it’s possible to buy the cyclical stocks early and wait for interest rates to fall. A common swing trading play is to then sell your position when interest rates bottom out.

Con: Timing Plays a Major Role

Unless you’re very good at analyzing and timing the major economic changes as they happen, it’s possible to lose out with discretionary holdings. For example, regardless of what the media and financial news sources say, it’s often difficult to say whether things are about to get better or worse. If you buy a cycle stock at the wrong time, near the top of an upswing, for example, your entire investment is at risk during even a mild recession or pullback. Traders have been trying to time the market since there was a market, and it’s a highly intricate affair even in the best of times.

Pro: Volatility

Most of the time you hear the word volatility, it’s used in a negative way. But, for a certain class of investors, the idea of larger than usual price swings is a good thing. Those who want to do better than the benchmark investments look to discretionary/cyclical stocks as a way to outperform the market. In the discretionary sector, technology companies are a popular swing play. That’s because the entire tech niche is more tied to the health of the overall economy than most other kinds of companies. Hence, tech prices tend to rise more than the benchmark in a rising market.

Feature Image Credits: Photo by Burak K from Pexels

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April 19, 2021