Consumer Cyclicals

What Are Consumer Cyclicals?

Consumer cyclicals are a category of stocks that rely heavily on the business cycle and economic conditions. Consumer cyclicals include industries such as automotive, housing, entertainment, and retail. The category can be further divided into durable and non-durable sections: Durable cyclicals include physical goods such as hardware or vehicles while non-durables represent items that people consume quickly such as cleaning supplies, clothing or food.

Consumer cyclicals can be contrasted with consumer non-cyclicals also known as consumer staples.

Understanding Consumer Cyclicals

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.

Consumer Spending 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 starts to slow down, consumer cyclical companies experience declining sales and earnings putting pressure on their stock price. The consumer cyclical sector tends to underperform most other sectors when the economy is weak. However, the sector typically outperforms most sectors in the early stages of an economic recovery. For the 10-year period beginning in 2006, the consumer cyclical sector led all sectors in the economic recovery with a total return of 134%.

The Role of Consumer Cyclicals in a Portfolio

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.