What are cyclical stocks and why are they interesting in a recovering market

When the economy is growing, many still stick to traditional growth and dividend stocks, forgetting that big profit opportunities are waiting elsewhere. That’s the cyclical stocks themselves. If your portfolio isn’t growing in line with the economy, you might have missed this type of stock.

Cyclical stocks are stocks that are highly volatile; a company's profits and revenues will fluctuate according to the economic cycle. They do not follow a fixed schedule but depend on demand and supply. Some cycles may last 1 year, 5 years, or 10 years, depending on the industry and market conditions.

The economic cycle has four main phases: Recovery (rebound) when the economy begins to expand; Peak when the economy is at its height; Recession when it enters a downturn; and Trough, the lowest point. Understanding these cycles helps you better time your investments.

Most cyclical stocks come from industries such as shipping, refining, agriculture, petrochemicals, coal, and steel—all of which tend to have profits that rise and fall with the global economic conditions.

Good cyclical stocks to consider investing in now:

NVDA is at the heart of the booming AI growth. The company dominates over 80% of the AI chip market. Growth is expected to reach 35% in 2025. Despite a P/E ratio of 40, the PEG ratio at 1.2 makes it fairly attractive. It holds over $20 billion in cash and has almost no debt.

Caterpillar (CAT), a giant in construction machinery, benefits directly from global infrastructure investment plans, especially in growing markets like Asia and South America. P/E is only 15. Backlog exceeds $30 billion, and it has a 25-year history of steadily increasing dividends.

JPMorgan, the largest bank in the U.S., benefits from falling interest rates. Price-to-Book ratio is just 1.8, very low for a bank with a 16% ROE and a CET1 ratio of 14.5%.

Steel producer MT benefits from the resurgence of the manufacturing and construction industries. Steel prices are expected to rise 15-20%. P/E is only 5, very low. Free Cash Flow Yield is 15%, enabling share buybacks and steady dividends.

LVMH, the luxury goods empire with 75 brands including Louis Vuitton and Dior, benefits from the purchasing power of the wealthy and China's recovery. Gross margin is 65%, higher than the industry average. Founder Bernard Arnault owns over 40%, showing strong confidence.

Len, a leading U.S. homebuilder, benefits from falling interest rates, expected to stay below 5.5%. Millennials are entering first-time homebuying age, increasing demand. P/E is only 10. With land reserves over 300,000 plots and a profit margin of 21%.

Other cyclical sectors worth noting:

Semiconductors: ASML, MediaTek, SK Hynix, Qualcomm are growing from investments in technology and AI. The market is expected to grow 15% by 2025.

Automobiles: Volkswagen, Hyundai, BMW, BYD benefit from the delayed vehicle replacement cycle. Global sales are projected to increase by 8%.

Banks: JPMorgan, Goldman Sachs, Bank of America are likely to rise during the economic recovery phase.

Advantages and disadvantages:

Advantages: High profit potential from price volatility. Skilled investors can profit significantly in the short term. Investing in cyclical stocks helps predict market trends over the long term. It allows for portfolio diversification and risk reduction.

Disadvantages: High volatility entails high risk. Requires deep understanding of economic cycles. External factors like government policies and global economic conditions pose risks. Not suitable for long-term wealth preservation.

Unlike defensive stocks:

Non-cyclical or defensive stocks perform well regardless of economic conditions. They produce essential goods that consumers always need, such as utilities, healthcare. Examples include Coca-Cola, J&J, Tesco, Diageo, NextEra Energy.

Summary:

Understanding the types of stocks you invest in helps craft different trading strategies. For cyclical stocks, it’s crucial to grasp how business performance relates to economic conditions and seasons, which influence demand and supply. This understanding helps you better visualize price movements and choose appropriate entry points for cyclical stocks.