This sector is also referred to as consumer discretionary. Industries in the consumer discretionary sector include automobiles; apparel; consumer services such as hotels, entertainment, and restaurants; retailing; and residential construction. Because the goods are non-essential, consumer cyclical stocks generally move in tandem with the market.
How Do Consumer Cyclicals Work
Buying consumer cyclicals is an aggressive strategy. While market timing isn’t the only part of consumer cyclical analysis, buying cyclical stocks means the investor is betting that the market will trend upward indefinitely. When the market is going up, people have money to spend, so cyclicals do well. When it is in decline, budget constraints cause people to spend only on what they need—and cyclicals lose sales. An example of this phenomenon is seen in the volatile returns of consumer discretionary stocks during most of 2020 and 2021. When the COVID-19 pandemic started and the market initially crashed, consumer cyclicals did poorly. You may remember stores being sold out of consumer staples such as toilet paper, but sales of discretionary goods suffered at the same time. The demand for consumer staples in a bad economy was so high that stores either had to limit quantities or had empty shelves. Consumer cyclical companies on the other hand, suffered from restrictions on purchases, whether budget- or policy-related, and their sales went down as a result. Once federal stimulus checks arrived and the economy started opening up, the stock market responded well, and so did consumer cyclicals. This can be confirmed with the same example above: Starbucks’ stock rose from $78 a share in early May 2020 to $110 a share in November 2021. Unlike other stocks, the best time to buy consumer cyclicals is often when they have high valuation ratios. If a cyclical stock’s price-to-earnings (P/E) ratio is high, it could be because earnings are in a downcycle that will soon turn. Conversely, if the P/E is low, it may be because the company’s earnings are peaking in an upcycle that won’t last forever. Of course, further analysis is needed to determine the cause of a stock’s abnormally high or low P/E.
Consumer Cyclicals vs. Consumer Staples
Here’s a chart to compare aspects of these two investment sectors: The consumer staples sector had middle-of-the-pack returns during the bull market discussed above. Stocks in the sector generally posted increased share prices and looked overvalued after a year and a half, but they did not have quite the same returns as consumer cyclicals. Costco Wholesale Corp. (COST) is a good example of a consumer staple stock. Costco makes most of its money from membership premiums, and in down markets, most people keep their Costco memberships to acquire discounted food, clothes, and other products. This was demonstrated in the 80% rise of Costco’s stock price from a level around $311 in early March 2020 to a closing price of about $558 in early December 2021.
What It Means for Individual Investors
Individual investors looking to purchase consumer cyclicals can do so easily by buying individual stocks or using exchange-traded funds (ETFs). Fidelity also offers industry-specific consumer cyclical ETFs, such as those invested in automotive or construction portfolios.
