WHAT ARE CYCLICAL STOCKS?
You may have heard about cyclical stocks – so what are they?
And should we invest into cyclical stocks? Or why not?
Generally, stocks are considered cyclical or non-cyclical.
They refer to whether the company’s stock prices are subjected to and highly corelated to the roller-coaster rides or cyclical nature of the economy.
According to Investopedia: “Cyclical stocks represent companies that make and/or sell discretionary items and services many consumers buy when the economy is doing well. These include restaurants, hotel chains, airlines, furniture, high-end clothing retailers, and automobile manufacturers.” Banks can also be considered cyclical stocks.
As we look deeper into our current situation, it is not difficult to see why.
When we were optimistic of the economy, businesses were making profits, jobs were stable, and most people were confident that they’d find the next job easily; that was when people would choose to eat out, treat themselves to a fancy trip, or buy themselves a new car.
The converse is true currently. “These are also (the) goods and services people tend to forgo
when times are tough. When people stop or hold off buying because of a reduction in
purchasing power, company revenues may start to fall. This, in turn, puts pressure on stock prices, which also start to drop. In the event of a long downturn, some of these companies may even go out of business1.”
The question remains: So is it time to buy into airline or bank stocks now that they are so cheap? It seems easy to decide since the adage remains: “BUY LOW, SELL HIGH”.
Yet, when you look at the chart above that depicts the emotional highs and lows, it doesn’t seem so straightforward anymore. And of course, it doesn’t mean that non-cyclical companies have no volatility. And would you prefer the stock prices of companies you own grow in multiples instead of just moving up and down along a horizontal line?
So how low would be low enough to buy into these stocks? Consider an airline stock such as Singapore Airlines (SIA):
SIA jumped 21% on 6th May 2020, and then fell to $4.40, which was still 4.8% higher than the stock price the day before. Sounds good! However, would you still buy this stock if you see it from a longer-term perspective?
The price for the stock seems low, but the price has generally moved along a horizontal line for many years. Thus, what’s more important to consider is the valuation, and not just the price.
What about banks? Perhaps we could look at DBS’s share price as an example:
Picking up cyclical stocks could be an opportunity cost to you and your portfolio when you could be owning a company with structural growth instead. We last wrote about choosing companies like that in our 13th April newsletter.
As structural growth companies get more valuable over time, not only do the share price continue to perform well over time, they also usually recover sooner from crises since they are impacted due to sentiments, and not because of their fundamentals.
We had previously featured Microsoft as a structural growth company, and its share price has recovered almost to its last peak in February this year.
If you already have structural growth winners like Microsoft in your portfolio – congratulations! However, if your portfolio has many cyclical stocks or companies that might be structural losers, it could be time to replace them with better players.
For the share prices of companies that were fundamentally hit, they could be suffering from an injury that could take years to recover or not recover at all.
Referring to the chart above, if you have Option 1 or 2, which would you choose?
Do speak to your Unicorn consultant if you would like to know more or have further queries.
Note: We will increase the frequency of our communication with you to weekly during the current turbulent times. We will continue to communicate monthly with you during usual times.
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