Cyclical stocks tend to move with the economy, often emphatically.
When the 2008 financial crisis hit, auto stocks and others plummeted. Ford, for example, fell from about $8 to just over 1$.
However, as the economy revived these same stocks came roaring back, moving from just over 1$ to $18 by 2011 .
Similarly, during economic booms, luxury goods and travel movements are among some of the biggest gainers in the market as consumer spending picks up.
Economic Expansion Effects
When the economy is recovering from a recession, cyclical stocks usually increase in value significantly. One of the principal reasons is that the disposable income of the general population increases along with levels of consumer confidence . For instance, after the Great Recession of 2008, consumer discretionary companies such as Amazon and Apple experienced explosive growth. In 2010, the stock price of Amazon was more than 34% higher than it was in 2009, and Apples grew by nearly 53%.
The information above serves to illustrate one example of the phenomena, which could be explained by other such circumstances. For example, the purchase of cars greatly increases in periods of an economic boom because people are more secure about their finances. Vivo et al . note that in the US, sales also grew after the 2009 recession, from 10.4 million units to nearly 17 million in 2016.
There are other factors liable to affect the stock prices of these companies. For example, economic growth also leads to businesses increasing their levels of capital expenditure: when the future is looking secure for a company, its management is more likely to invest in a new project than otherwise. Overall, the general recovery of the economy leads to a rise in the price of stock. Simon et al. note how the SPDR S&P Homebuilders ETF increased by 60% in the years following the end of the recession: a sign of improving markets for construction and purchases of housing.
It has been said that “Be fearful when others are greedy, and greedy when others are fearful” (MarketWatch, 2008). This principle is the core of cyclical stocks: people who use the information about the state of the economy to predict the future adjust their portfolio accordingly.
Recessionary Declines
Cyclical stocks were mentioned in the statement of the problem. They are some of the most vulnerable assets in terms of economic downturns as they become flat out of consumer spending and business investment which would be the first kind of news which would decrease. The performance of cyclical stocks is usually the sharpest and the swiftest one which is indicative of the entire economic sentiment.
Thus, during the global financial crisis of 2008, major automotive stocks such as General Motors and Ford lost their values across the entire decade in accordance with the declines in car sales. For example, Ford’s share price decreased from about 8 USD at the beginning of 2007 to less than 2 USD by December 2008. The available data on economic recessions suggests that hospitality and travel industries are among the most vulnerable during recessions.
In particular, it was reported by STR Global that the US hotel industry saw a 16.7% decline in revenue during 2009 which was the second year of the recession in terms of hotels sales.
The abovementioned impact during recessions usually results in specific changes in the operations of companies such as the freezing of hiring or the reductions of inventory and even closures of certain locations simply to ensure the survival of the organization.
Naturally, all of the activities are primarily oriented towards preserving the company by means of preserving the cash flow. However, this also has a negative impact on the share price of the company in the short term which is becoming even flatter. John Templeton is often cited in this regard as he used to say that “The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell“.
Consumer Spending Trends
The performance of cyclical stocks is driven by consumer spending due to the fluctuation of these expenditures with economic conditions. This fact affects a number of sectors such as retail, automotive, and leisure. For instance, as the U.S. economy was booming in the mid-2000s, consumer spending increased, driving substantial gains in the stock market, especially in consumer discretionary stocks . In a recent article, it is reported that both Target and Walmart saw their quarterly sales and earnings increase more than originally planned in this period due to the high rate of consumer spending. Importantly, their stocks and those of other retail giants skyrocketed.
These points can be corroborated with the following specific pieces of data. According to the information available, the figure for the Consumer Confidence Index was approximately 100 in the run-up to 2007. This indicator subsequently fell to about 25 in 2009 as the recession started, pushing down consumer spending. As one would expect, at this point, stocks their prices experienced a significant drop as well, given their reliance on discretionary spending. However, as the economy improved, consumer spending was on the rise, and the stocks prices have been steadily increasing since at least 2010. Therefore, the changes in the expenditures of this group of consumers impact the stock prices of those companies significantly in a number of direct consumer services and their satellite industries.
Notably, the changes in consumer spending affect not only those stocks but also the prices of the related businesses. For instance, as travel and tourism expenditures by Americans experienced an 8% increase in 2015, their price of the relevant stocks such as Delta Airlines and Marriott Internationals also rose. Overall, it is important that these expenditures and, hence, the related stocks reflect the unique consumer everyday decisions rather than compulsory actions driven by the central policy-makers.
Industry-Specific Shifts
The answer is definitely yes since the majority of cyclical stocks can be significantly affected by the shifts within a particular industry. The changes in an industry definitely create leverage and, as a result, influence the performance and perception of a particular company . The greatest example is the tech industry of the late 1990s when the dot-com boom raised the stock prices of Microsoft, Cisco, and others to enormous levels .
The following bust, in turn, also leaked over to the stock market and similarly produced the drastic changes in the performance of this type of stock. In fact, the trend can be traced using the historical data as well. For example, in the early 2000s, the emergence of digital media resulted in the transition of advertising from the print and broadcast industries .
This circumstance, in turn, resulted in a sharp drop in the value of newspaper stocks, while the share value of the emerging internet companies, such as Google, which went public at the price of $85 in 2004 and by 2007 managed to exceed $700, was noticed independent from the trends that took place in the general stock market.
Similarly, the implementation of new technologies, policies, including stringent environmental regulations supporting the shift to electric vehicles should be considered. This example is evidenced by the performance of Tesla, which price of approximately $30 in 2010 grew to $600 by the end of 2020 .
Thus, one should regard the wisdom of Warren Buffett, which is that “You should invest in a business that even a fool can run because someday a fool will be running it” as a recommendation to know the fundamentals of the industry and the cycles since this can assist in understanding the stock fluctuations and benefit from the changes.
