We delve deep into one of the most popular stock and index filters
Two terms that frequently surface when talking about stocks and funds are “cyclical” and “non-cyclical”. But what do they mean exactly – when do these cycles happen, what governs them and more importantly, how can this help a trader make a decision on what and when to buy or sell?
Lets start with a couple of definitions. When a cycle is mentioned it means an economic one. One of the inherent traits of capitalism is that it never develops in a constant upward movement, but rather has periods of progress and regress due to its built in inefficiencies (although some argue that having periods when the going gets tough makes things better in the long run).
When a company stock, or a country, or a fund for a sector is referred to as cyclical, then that would mean their performance is connected with the larger economic cycle in the respective country, or even the global economy. If they are mentioned as non-cyclical then they would be considered as an instrument whose performance is largely independent of what is going on in the respective economy.
Examples of cyclical sectors are those business areas for which people spend when they have more disposable income. The amount of this money in the population is usually in a correlation with large economic indicators like GDP, inflation, employment and manufacturing. A prime example of such sectors are tourism and cars. You won’t go on an expensive vacation if you’re barely making your rent and meeting your food expenses and you won’t buy a new car if the old one still gets you from A to B. But other sectors and companies depend solely on themselves when it comes to performance.
A prime example of a non-cyclical sector (occasionally referred to as “defensive”) is healthcare. A company like the British Astra Zeneca is shielded from the ups and downs of the local economy, as it produces medicine that is of vital necessity for its end-clients. This is the main differentiator – companies and sectors that produce things of vital need for our existence like pharmaceuticals, utility and food companies are non-cyclical, while those who make goods and services who are upgrades on our basic needs – entertainment, luxury cars, chocolate, etc. – are cyclical.
Country ETF’s are another great addition to our instrument range. They provide a straightforward way to trade the economic fortunes of countries whose largest indexes are either less developed or are harder to access. Contrary to what some might believe, these ETFs can be used for short-term trading. They are connected with the largest global economies and react in different ways to the key announcements coming for example from the Fed and ECB. Additionally, most of them have their own developments that generate sharper moves, examples being our ETFs for China, Canada and Korea.
Let’s see how researching a German auto company in terms of it being cyclical might play out. You check out their website, their products and like what you see. Then you see the stock price – it’s stuck in a range and is currently moving downward. What are the reasons for this, the new model is excellent and sales are great?
Another bit of research is needed. Checking the German and European economic indicators (you can go to our calendar for these), as well as the level of the euro, are factors that influence the activities of large companies, regardless of their own innovation, efficiency and talent. You could say that this German automaker is too large for its own good, but the markets don’t care about that. They care about the bottom line.
These other factors, announced regularly, are influences on cyclicals. They permeate and influence the specific results and performance of such companies, proving the connectivity of the global economy. Currencies, interest rates, inflation, big shifts in how companies work, coupled with technological advances are the context in which they exist.
Think of these stocks and ETFs as ships in an ocean. Some are strong and fast, but sometimes they have to pass through a storm. Others can just wait it out.