Trading in the financial markets is a tricky proposition for most people. Several shares in the markets are quite vulnerable to any slowdowns and downturns in the nation's economy. Other shares might be quite profitable in any condition that may prevail in the economy. This makes them quite safe from any recessions that may take place. The economic activities in any nation keep varying throughout the good and bad times. This is known as the theory of cyclicality. The coronavirus pandemic caused a cyclical impact on the financial markets. The economically sensitive shares during this period came to be known as cyclical stocks. These shares saw a decrease throughout the economic downturn at the beginning of the pandemic. The shares of most of the firms saw a reversal in their fortunes after the economy of the nation started to recover again. Also, the low-interest rate regime and the stimulus programs given by various governments assisted in this reversal. In this article, we are going to find out more about cyclical stocks in the financial markets.

What Are Cyclical Stocks?

These are the types of shares in the financial markets whose financial performance of the underlying firm is affected by the modifications in the spending patterns of consumers and the wider national economy. An important question to ask when trying to find out the cyclicality of the firm is whether the users would need or demand this service or product even when there is a recession in the economy. Suppose the nation's economy was going to go through a sudden downturn. In that case, the purchases of many items such as vehicles and houses would see sharp decreases in demand from the users. So, the firms with valuations that increase during such periods of economic expansion and then decrease a lot during the recessionary periods are known as cyclical stocks. The condition of the national economy directly impacts their price. Also, the confidence that the user has related to the firm is tied to the present situation of the economy. This is because, as stated earlier, consumers look to cut back on their spending on some items if there are any concerns regarding an impending economic recession.

Cyclical Stocks vs. Seasonality

These types are quite unpredictable with regards to their overall timing than the seasonal stocks. So, making any investments at the wrong time on such stocks could result in a much worse outcome than the returns expected by the investor. An instance of an industry with cyclical stocks is the semiconductors industry. This is an industry driven by global gross domestic products and the trends in spending on IT by various enterprises around the globe. These types of sectors are known for heavy fluctuations. Also, trying to accurately predict the directional modifications in the gross domestic products and forecasting the recessions without inducing a big margin for error is not possible. The semiconductor industry is tied to the spending trends of the firms. But these are also hinged on the discretionary purchases by users in things such as devices, laptops, and smartphones. These types of purchases see a decline during various downturns in the economy of a nation.

The products that the industry has recently released have even shorter lifespans and have the tendency to become obsolete in a short time because of the current pace of swift innovation, which causes them to become out of date with even minor improvements. The build-ups and write-offs of inventory are quite frequent in the semiconductor industry. But the shares that are in season are more predictable than this because there are some clear patterns that are present. For instance, the retail industry is quite well-known for being a seasonal industry. This is because the user demand increases during the times of holidays. But the main difference in this regard is that the spending trends of users can be forecasted. This is affirmed by how retail firms get more staff as the year comes to a close and the public firms place more importance on sales performance across the holidays.

Different Cycles and their Cyclical Stocks

Predicting the various price movements in such stocks needs a great understanding of the overall business cycles. You may get positive investment and spending behavior when there is an economic boom. When the per capita incomes get much higher, consumers spend more on convenience and premium items. This increases the gains of firms that make such materials. This category also includes several utilities, including vehicles, air conditioners, refrigerators, televisions, etc. When there is an expansion in the economy, the firms that manufacture these materials get the highest growth rates in terms of gains because of the increased demand in the market. The higher gains of these firms, combined with the higher demand for the corresponding stocks, lead to an increase in the average price of the stocks in the financial markets. This, in turn, increases their profitability even more because of the increase in the firm's cash flow. But the firms with cyclical stocks are the most affected when there is a recession in the economy.

Any type of recession in the economy is marked by a slowdown. This affects the level of employment and production that is present. As the rate of unemployment increases in the economy, the overall demand for user goods typically falls. This leads to a marked decrease in the firm's total income and profit levels. The share prices of a lot of the cyclical stocks collapse when faced with such an economic scenario because of the lower volumes of production of these firms and the lower demand for stocks in the financial markets. So, the performance of cyclical stocks and fluctuations in the business cycle are directly related. Any upward growth in the economic output also leads to an increase in the profitability of the issuing firms. Any downward trend in the economic cycle causes a major decrease in the gains generated by these firms.

Conclusion

People who want to invest in firms that issue cyclical stocks should find out the present trends of the economy of the nation and the predicted returns on their investments to increase these gains. They must also learn about the various risk factors to ensure that the investments in the cyclical stocks are not affected financially by the fluctuations in the financial markets.