How to invest in cyclical stocks

“Everything moves in cycles” is a phrase you often hear thrown around the investing world and it’s a statement that is, without a doubt, absolutely true. But many people misunderstand how this phrase can be applied to the shares that one can own and in the overall investment space. In the world of income-producing assets (that shares fall into), there are many concurrent cycles all working in tandem and when you buy a share, it is important to understand which cycles that particular share may be moving in.

Let me explain. Most investors would be familiar with the ‘business cycle’. This refers to the pattern of economic growth that the global economy typically experiences over a long period of time and that the stock market typically follows. We normally have 5-10 years of economic growth and rising share prices, known as a ‘bull market’. This is usually interrupted by 6 months to 2 years of negative growth and falling stock prices, known as a bear market. Property prices are also heavily correlated with this cycle.

Most stock prices follow this general pattern to some extent. The ASX is an index that is dominated by resource stocks like BHP Group Ltd. (ASX: BHP) and banking stocks such as the Commonwealth Bank of Australia (ASX: CBA). These stocks are highly correlated with this business cycle as banking relies on demand for credit and resources on commodity prices, which are both barometers for economic growth.

Consumer staples stocks like Coles Group Ltd (ASX: COL), Wesfarmers Ltd (ASX: WES) and Coca-Cola Amatil Ltd (ASX: CCL) also follow this cycle, but in a slightly differing way. Investors regard consumer staples as ‘safer’ assets with big dividends and so if markets get a bit jittery, investors might flock out of banking shares and into consumer staples. Conversely, if a bull-market takes off, investors might start to feel some FOMO and pull money out to chase higher returns somewhere else.

Some shares like CSR Limited (ASX: CSR) run on their own cycle (in CSR’s case, the building and construction cycle). These kinds of cycles run more independently of the business cycle and respond to supply and demand within their own industries. This can offer an explanation to why CSR’s share price has trended down over the past year while the ASX has been making new highs.

Finally, some stocks can run on inverse cycles. Gold is a commodity that usually rises strongly when everything else is falling because investors often seek safety in precious metals. During times of growth, investors tend to forget about the yellow metal, but you only have to look at what the gold price was doing in 2008-2011 to see what I mean. Gold miners like Newcrest Mining Limited (ASX: NCM) move in harmony with the gold price and are often the only bright lights in a bear market as investors remember how much they like gold.

Foolish Takeaway

When you invest in a stock, it’s important to understand the cycle (or cycles) that the stock may be moving in. This can stop you from buying or selling at an inopportune moment. Not everything is always as it seems and digging a bit deeper on your stocks and the industries they operate in can give you a contrarian edge and a richer investing experience (no pun intended).