A:

Interest rates can be used to indicate the right time to buy a cyclical stock based on whether they are increasing or decreasing. Cyclical stocks are highly leveraged to the business cycle as are interest rates. As the economy expands, inflationary pressures accumulate. If there are shortages in labor, commodities or housing in addition to a strong economy, inflation can become a recessionary force as people begin to have less disposable income. When central banks detect that inflation is becoming a threat, they look to contract the money supply by raising rates. Raising rates causes the money supply to shrink as people invest their money in long-term securities to take advantage of higher rates.

During recessions, interest rates are cut to stimulate a slowing economy. Recessions are particularly brutal for cyclical stocks. During expansions, costs rise as production expands and people are hired. Competition also increases, attracted by high margins. The slowing demand causes prices to fall and companies with weaker balance sheets that are overleveraged may be forced to declare bankruptcy. Stronger stocks still have to cut costs as sales plunge by shutting down operations and letting go of workers.

In response to the economic environment, interest rates are cut. This is the time to buy the companies that were able to survive the recession. At some point, the economy bounces back. As demand returns, prices rise. Margins are strong due to the cost cutting over the recession. The reduced capacity also creates upward pricing pressure. The survivors thrive. Cyclical stocks are boom and bust. They have heavy debt loads and thin margins. Watching interest rates and buying when rates are low helps investors attain optimal entry points.

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