What is a Cyclical Industry?
How Does a Cyclical Industry Work?
Cyclical industries perform well when the economy is growing and suffer when the economy stagnates or shrinks. When jobs are scarce and disposable income is lower, people tend to hold off on purchasing cars, traveling, or buying new homes. But when employment is high and wages are rising, these industries often shine. This is why the automotive, construction, heavy equipment, and airline industries are examples of cyclical industries.
Cyclical industries can suffer during recessions, and companies in these industries are prone to bankruptcy if they don't have the cash or strong balance sheets necessary to weather a long recession. However, the bigger the economic boom, the more profitable these industries become.
Why Does a Cyclical Industry Matter?
Since stocks in cyclical industries often rise in good economic times and fall during bad times, investors attracted to stocks in cyclical industries are faced with the arduous task of trying to time the market. This means they must try to predict where the bottom of the business cycle is in order to buy these stocks at the optimal time and then predict where the top of the cycle is in order to sell at the optimal time.
Regardless, timing the market can be hard, given the fact that some cyclical stocks start bouncing back before a recession is actually over. Holding the stock of companies in cyclical industries over the long-term is therefore a somewhat controversial issue because economic downturns can take years to recover from.