A cyclical stock is highly correlated with movements of the business cycle, while a non-cyclical stock has little to no correlation with the business cycle.
An example of a cyclical stock would be automakers, which perform well in strong economies when consumers have the confidence to spend. On the other hand, non-cyclical stocks are consumers staples that people buy in good times and bad. No matter how well the economy performs, consumers continue buying staples such as toothpaste or detergents to keep their homes clean.
Cyclical stocks are businesses that flourish during economic expansions when consumer spending is high. Think automakers, home construction and companies that produce big-ticket items such as boats and furniture. Even apparel makers are considered cyclical, because consumers buy more clothes and shoes in strong economies.
During economic upswings, these businesses capture a good portion of the increases in spending, as consumers are more willing to allocate additional earnings to non-essential goods. However, during economic contractions, consumers cut their spending on non-essential goods, reserving cash for what they need most.
Non-cyclical stocks, or defensive stocks, comprise businesses that operate in industries that do well regardless of what the overall economy is doing. This is because these businesses offer essential goods, such as utilities. Luxury goods are nice to have. But consumers always need utilities such as water, electricity and gas. They continue buying food, household products and tobacco.
When confidence in the economy is low, and there is a potential for reduced salaries or jobs, consumers reserve what what money they have for essential goods. This increases the share price of non-cyclical stocks and reduces the share price of cyclical stocks.
Businesses in non-cyclical industries have sticky demand, meaning that demand for their product or service is always there. Businesses in cyclical industries are faced with fluctuating demand for their products and services. Demand is tied to consumer confidence and the overall economic environment.