What Are Consumer Cyclicals?
Consumer cyclicals are a category of stocks that rely heavily on the business cycle and economic conditions. Consumer cyclicals include industries such as automotive, housing, entertainment, and retail. The category can be further divided into durable and non-durable sections. Durable cyclicals include physical goods such as hardware or vehicles while non-durables represent items that people consume quickly such as cleaning supplies, clothing or food.
Understanding Consumer Cyclicals
The performance of consumer cyclicals is highly related to the state of the economy. They represent goods and services that are not considered necessities but discretionary purchases. During contractions or recessions, people have less disposable income to spend on consumer cyclicals. When the economy is expanding or booming, the sales of these goods rise as retail and leisure spending increases. Companies in the retail and leisure sector include General Motors Company, Walt Disney Company, and Priceline.com.
Consumer Spending Sensitivity
Consumer cyclical companies, also referred to as consumer discretionary companies, are particularly exposed to fluctuations in consumer spending. Consumer spending is affected by economic factors such as interest rates, inflation, unemployment and wage growth. When economic conditions begin to deteriorate, consumers are less inclined to spend their money on non-essentials, for example, flat screen televisions, vacations, new clothes, and new cars. Consumer confidence is an important gauge of consumers’ attitudes toward spending. A decline in the Consumer Confidence Index (CCI) often precedes a decline in consumer spending on discretionary items.
When the economy starts to slow down, consumer cyclical companies experience declining sales and earnings putting pressure on their stock price. The consumer cyclical sector tends to underperform most other sectors when the economy is weak. However, the sector typically outperforms most sectors in the early stages of an economic recovery. For the 10-year period beginning in 2006, the consumer cyclical sector led all sectors in the economic recovery with a total return of 134%.
The Role of Consumer Cyclicals in a Portfolio
The consumer discretionary sector is considered more volatile than the consumer staples sector, which is less sensitive to economic changes, but it offers greater potential for growth. A balance of stocks from both sectors would provide greater stability over the long term. Investors can also increase stability by focusing on consumer cyclical stocks that pay dividends. Dividends can cushion the downside movement of consumer cyclical stocks. Examples of companies with a long history of dividend payments include Wal-Mart Stores Incorporated, Lowes Corporation, Genuine Parts Company, and Target Corporation.