Understanding Consumer Cyclicals: Key Examples and Comparison to Noncyclicals

Definition

Consumer cyclicals are stocks of companies that produce nonessential goods and services, whose performance is tied to the economic cycle, typically going up during expansions and down during recessions.

What Are Consumer Cyclicals?

Consumer cyclicals are stocks whose performance rises and falls with the economy, thriving in growth periods and weakening during downturns. They include industries such as automotive, housing, entertainment, and retail, divided into durables, such as vehicles and appliances, and non-durables, like clothing and food.

Unlike consumer noncyclicals, which remain steady in recessions, cyclicals carry higher risk but can offer strong returns in economic expansions.

Key Takeaways

Consumer cyclicals include industries such as automotive, housing, entertainment, and retail.
These stocks rise in value during economic booms and decrease during recessions.
Unlike consumer staples, cyclicals rely heavily on discretionary spending.
Cyclical companies face declining sales during economic downturns but outperform others during recoveries.
Balancing cyclical and defensive stocks can stabilize a portfolio over the long term.

How Consumer Cyclicals Respond to Economic Changes

Consumer cyclicals perform based on the economy's state. They include goods and services that are not essential, known as discretionary purchases. During recessions, people have less disposable income for these items. When the economy is expanding or booming, the sales of these goods rise as retail and leisure spending increases. Companies in the retail and leisure sector include General Motors Company, Walt Disney Company, and Priceline.com.

Companies whose stocks are cyclical include car manufacturers, airlines, furniture retailers, clothing stores, hotels, and restaurants. When the economy is doing well, people can afford to buy new cars, upgrade their homes, shop, and travel. When the economy does poorly, these discretionary expenses are some of the first things consumers cut. If a recession is severe enough, cyclical stocks can become completely worthless, and companies may go out of business.

Factors Influencing Consumer Cyclical Sensitivity

Consumer cyclical companies, also referred to as consumer discretionary companies, are particularly exposed to fluctuations in consumer spending. Consumer spending is affected by economic factors such as interest rates, inflation, unemployment and wage growth. When economic conditions begin to deteriorate, consumers are less inclined to spend their money on non-essentials, for example, flat screen televisions, vacations, new clothes, and new cars. Consumer confidence is an important gauge of consumers’ attitudes toward spending. A decline in the Consumer Confidence Index (CCI) often precedes a decline in consumer spending on discretionary items.

When the economy slows down, consumer cyclical companies see declining sales and earnings, which pressure their stock prices. This sector usually performs worse than others during economic downturns but often outperforms in early recovery stages. From 2006, over ten years, it led in economic recovery with a 134% return.

Building a Balanced Portfolio With Consumer Cyclicals

The consumer discretionary sector is considered more volatile than the consumer staples sector, which is less sensitive to economic changes, but it offers greater potential for growth. A balance of stocks from both sectors would provide greater stability over the long term. Investors can also increase stability by focusing on consumer cyclical stocks that pay dividends. Dividends can cushion the downside movement of consumer cyclical stocks. Examples of companies with a long history of dividend payments include Wal-Mart Stores Incorporated, Lowes Corporation, Genuine Parts Company, and Target Corporation. Investors frequently choose to use exchange-traded funds (ETFs) to gain exposure to cyclical stocks while expanding economic cycles. The SPDR ETF series offers one of the most popular cyclical ETF investments in the Consumer Discretionary Select Sector Fund (XLY).

Cyclical stocks are viewed as more volatile than noncyclical or defensive stocks, which tend to be more stable during periods of economic weakness. However, they offer greater potential for growth because they tend to outperform the market during periods of economic strength. Investors seeking long-term growth with managed volatility tend to balance their portfolios with a mix of cyclical stocks and defensive stocks.

The Bottom Line

Consumer cyclicals, which span industries like housing, retail, and autos, rise in value during economic growth and fall in recessions due to their dependence on discretionary spending.

These stocks offer strong growth potential but higher volatility than noncyclicals. Balancing both in a portfolio can reduce risk, and choosing dividend-paying cyclicals can help cushion downturns.