What is a cyclical industry (short definition)
A cyclical industry is one whose sales and profits move noticeably with the overall economy. When the economy expands, demand and revenue in these industries tend to rise; when the economy slows, demand and revenue tend to fall. Cyclical firms often respond by trimming payroll and discretionary spending in downturns and boosting hiring and incentives during expansions.
Key points
– Cyclical industries depend on business-cycle sensitivity — they gain in expansions and lose in contractions.
– Sectors that sell nonessential or long‑lived goods and services are typically most cyclical.
– Countercyclical or defensive sectors (e.g., utilities, health care, consumer staples) change far less with the cycle.
– A standard way to quantify cyclicality is correlation of industry returns or revenues with broad economic or market indicators.
The business cycle (four phases)
– Expansion: Output, employment and income rise; consumers have more discretionary money; asset prices typically increase.
– Peak: Growth reaches its high point and begins to slow.
– Contraction: Output and employment fall; consumers pare discretionary spending. A commonly cited shorthand for a recession is two consecutive quarters of GDP decline, though official U.S. recession dating is done by the National Bureau of Economic Research (NBER).
– Trough: Activity bottoms and the economy begins recovering toward the next expansion.
Why some industries are cyclical
– Exposure to discretionary spending: People cut vacations, luxury goods and big-ticket items first when incomes fall.
– Dependence on durable or capital goods: Construction, heavy equipment, and raw‑materials producers rely on investment spending that moves with the cycle.
– Sensitivity to interest rates: Rising rates raise borrowing costs and can depress demand for financed goods (homes, autos).
– High operating leverage: Firms with large fixed costs see profit swings amplified by smaller changes in revenue.
Examples (typical cyclical and countercyclical industries)
– Commonly cyclical: autos, airlines, hotels, leisure/tourism, heavy machinery, homebuilders, certain raw materials.
– Commonly countercyclical/defensive: utilities, many healthcare providers and products, consumer staples (food, household essentials).
Cyclical stocks
A cyclical stock is an equity whose price and earnings closely follow macroeconomic trends. In good macro conditions these stocks often outperform; in downturns they often lag. Measuring the historical correlation of a stock or sector return with a broad market index (or GDP growth) gives a quantitative sense of cyclicality.
How to assess whether a company or