How to invest in cyclical stocks

Its important to think about cycles in stocks when you are investing

a woman

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

"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).

Motley Fool contributor Sebastian Bowen has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of and has recommended COLESGROUP DEF SET and Wesfarmers Limited. The Motley Fool Australia has recommended Coca-Cola Amatil Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

More on Investing Strategies

Happy young couple saving money in piggy bank.
Growth Shares

Where to invest $2,500 into ASX 200 shares today

Analysts think these shares could be top buys for investors with money to invest.

Read more »

A woman sits at her computer with her chin resting on her hand as she contemplates her next potential investment.
Dividend Investing

Hunting for passive income? Here's everything you need to know about the latest NAB dividend

NAB revealed its interim dividend payout this morning.

Read more »

A couple makes silly chip moustache faces and take a selfie on their phone.
Dividend Investing

I think these 2 high-yield ASX dividend shares are buys in May

These businesses offer significant passive income.

Read more »

Wife and husband with a laptop on a sofa over the moon at good news.
Dividend Investing

2 ASX dividend stocks to buy for juicy 5% to 8% yields

These shares are being named as buys for income investors by brokers.

Read more »

Man pointing an upward line on a bar graph symbolising a rising share price.
Dividend Investing

3 growing ASX dividend shares to buy and hold

Analysts are feeling positive about these shares. Let's see what they are forecasting for them.

Read more »

Joyful woman at a beach on the Gold Coast with her arms spread out.
How to invest

How to bank $10,000 a year in passive income from these 3 top ASX shares

Here’s how I’d go about building a $10,000 passive income stream from these top ASX stocks.

Read more »

Two people having a meeting using a laptop and tablet to discuss Seven West Media's balance sheet
Growth Shares

3 excellent ASX shares to buy for your SMSF

Analysts think these shares could be top picks for SMSF investors. Let's find out why.

Read more »

A woman relaxes on a yellow couch with a book and cuppa, and looks pensively away as she contemplates the joy of earning passive income.
ETFs

3 ASX ETFs to buy for passive income in May

Don't like stock picking but want passive income? Here are three funds that could help you.

Read more »