What are Cyclical Industries?

Industries that follow business cycles or trends are known as cyclical industries. An important thing to know about cyclical industries is that their profitability is closely tied to market cycles. This means companies within a cyclical industry can be relatively profitable during peaks in the cycle and may experience lows during troughs. Cyclical industries tend to sell non-essential items that may decline when economies aren’t performing well.

How Cyclical Industries Work

To understand cyclical industries, one must understand how business cycles work. It has four stages, which include expansion, peak, contraction and trough.

Business Cycles

Here is an explanation for each stage of an average business cycle.

Expansion
During the expansion phase, the economy grows. Some characteristics of economic growth include higher productivity, lower unemployment and higher consumer spending. This type of economic circumstance can also lead to more investing.

Peak
Economic growth comes to a standstill once a business cycle reaches its peak. This is because there’s only so long an economy can continue supporting expansion. As a result, right after a peak, the next phase is economic decline.

Contraction
When an industry contracts, you often begin seeing visible signs of decline. For instance, dips in demand and wages may occur, reducing comsumption. Another major indicator is that the economy at large may decline and the country’s GDP may even go lower than what it was at the start of the business cycle.

Trough
A company troughs when it reaches its lowest point. Some indicators of the bottom of the cycle might be unemployment no longer rising and demand no longer declining. Once the trough period is over, the cycle starts again with expansion.

Examples of Cyclical Industries

There are multiple other examples of cyclical industries. Some include:

• Automobile: New vehicles are sometimes a necessity but they can also be a luxury. When the economy isn’t doing well, car sales may suffer as a result.
• Finance: The finance industry is robust and can include a gamut of products and services ranging from financial advisors to trading securities on the stock market. Both may suffer during times of economic downturn and may thrive when people have money to spend and feel economic security.
• Real estate: Similar to the finance industry, when the economy isn’t doing well, real estate may not be a priority for investors and home buyers. That said, it depends on the state of the economy as the U.S. has seen rising inflation and a stubbornly high demand for real estate simultaneously.
• Discretionary goods: Products and services that aren’t necessities go into the discretionary goods bucket. This could include furniture, fast food, or certain electronics like TVs. They may perform well when people have a surplus of disposable income but not when budgets are tight.
• Travel: While people travel throughout the year, some seasons are more popular than others. For instance, travel may peak during holidays whereas it may be more quiet during off-season months which varies between states and countries. If disposable income decreases people will likely travel less or take less expensive trips.

Cyclical Industries and Investing

A benefit of cyclical industries is you can sometimes predict which seasons will be high and which low. This gives businesses a chance to plan for fluctuations so they can withstand economic volatility.

Understanding cyclical industries can be helpful for investors as they have a better idea of when the value of their investment may rise and fall. This can help investors make informed decisions about when to buy and sell, especially for active investors. Keep in mind that it’s impossible to time the market, but cyclical markets help investors at least identify patterns.

Passive investors may choose to ride the wave of cyclical industries seeing as they’re investing for the long-term. The main advantage of investing in cyclical industries is that during peaks, there’s potential for generous returns. In the same regard there’s high risk during downturns. As with any portfolio, it’s a good rule of thumb to ensure balance and diversification.