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What is Cyclicality?

What is Cyclicality?
Date Added: July 19th, 2004

By Chris Stallman  

People on TV are always talking about "cyclicality" and I think I know what they're talking about but can you give me a brief summary?
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Thanks for the question.  Cyclicality is a pretty commonly recurring theme in the investment world.  Cyclicality actually comes in three flavors: cyclicality, non-cyclicality, and countercyclicality. Luckily, they're pretty easy to grasp so it won't take too much explanation.

Cyclicality

When talking about stocks cyclicality basically means that stocks follow the general macroeconomic conditions.  A cyclical stock is one that typically performs well when the economy is good and badly when than when the economy is weak.  This sounds pretty much like common sense but it's important to remember that not all companies fall into this group, as you'll see in a minute.

Non-cyclicality

Non-cyclical stocks are stocks that don't necessarily move in tandem with the overall market.  These typically include healthcare companies because people still go to hospitals and buy cough medicine when the economy is bad.  And when the economy improves, it doesn't mean they go to the hospital any more often.

There are degrees to which a stock can be non-cyclical.  Take grocery stores for example.  If the economy is weak, it doesn't mean that you won't buy food for your family.  However, you might start clipping coupons and buying more generic items, which lowers the average ticket at a grocery store.  In this case, these companies would be "semi-cyclical."

Countercyclicality

Countercyclicality is really hard to assess.  A countercyclical stock is one that typically does well when the economy takes a downturn.  People often argue that alcohol companies are countercyclical because studies have shown that people drink more when unemployment is high.

Countercyclicality can even be slightly evident in retail companies.  I know, I know.didn't I just say retail stocks are cyclical?  How could some be countercyclical?  Well, take TJX for example.  TJX owns TJ Maxx and Marshalls stores, which are clothing retailers.  Clothing is seen as a discretionary purchase, meaning that you don't need to buy new clothes.  So when the economy does poorly, people often look to cut their discretionary spending by shopping for cheaper clothes.  That's where TJX steps in.  They offer their customers name-brand apparel at prices much lower.  So their customers can still by the same type of clothes as they normally would but at lower prices.  We call this the "trading down effect."

Understanding cyclicality is important because it gives you a sense of how your investments will do when the economy shifts gears.  Obviously if unemployment is rising and the economy is turning sour, you may not want to buy shares in Tweeter Home Entertainment, which sells high-end plasma televisions.  It pretty much comes down to common sense.but it's important to understand nonetheless.

 

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