When looking to manage your stock portfolio, it is best to have a mix of cyclical, also called offensive, and non-cyclical, also known as called defensive, stocks to generate healthy growth no matter the state of Wall Street.
Cyclical stocks are usually affected by macroeconomic changes in that overall economy, often known for following the cycles of expansion, peak, recession and recovery. Non-cyclical stocks, on the other hand, tend to grow with the broader market regardless of economic trends or even economic slowdowns.
Know the Offense Cycle
Cyclical stocks are public companies that sell consumer discretionary items, which can be affected by consumer confidence in the future economy. Examples include car manufacturers, airlines, clothing retail, hotels, and restaurants. These stocks are defined by their consumer function into three categories: durables, nondurables, and services.
Durable stocks are equities that involve manufacturing or distribution of physical goods that do not expire quickly, but have an expected lifespan. Think of car manufactures like Ford (NYSE: F) or GM (NYSE: GM) who produce vehicles that will eventually need to be replaced by the consumer. When the economy is in a period of growth, consumers are more likely to replace their older cars, betting on better, more stable future finances. Conversely, when the economy starts to enter a downturn, consumers often choose to keep a car that they may be unsatisfied with due to uncertainty surrounding the job market and cost-of-living expenses.
Nondurables include stocks that are more fast-moving consumer goods. A good example of nondurable companies are retail stocks like Nike (NYSE: NKE) and Target (NYSE: TGT), both of which offer products that are expected to replaced more often. These stocks are more likely to follow the up and down trends of the consumer discretionary market, as consumers may tailor their spending habits to match the health of the economy.
Services include stocks that are separate from consumer goods, which include companies that facilitate travel, entertainment, and other leisure activities. These are usually the first type of companies that consumers will forego in time of economic downturns. A good example of a services company is Walt Disney Co. (NYSE: DIS), as they provide consumers entertainment services through their media and parks experiences.
Cyclical stocks are often used to predict future growth of the broader stock market, as they rise and fall with the economic cycle. These types of stocks offer the greater potential to outperform in periods of market strength and are usually abandoned in times of recession.
Investors can also add to their portfolio through exchange-traded funds, which carry less risk as their provide broader market exposure by following indexes instead of individual stocks. Popular offensive ETFs include the SPDR ETF Consumer Discretionary Select Sector Fund (NYSE: XLY) and iShares Global Tech ETF (NYSE: IXN).
Playing Defense
Non-cyclical stocks are known as defensive as they are able to defend their value no matter the state of the economy. Defensive stocks usually fall more into the consumer staples and utilities sectors, which are goods and services that consumers and businesses usually cannot function without.
American Water Works (NYSE: AWK) represents a good example of a non-cyclical stock, as consumers will need to access water even during an economic depression. The same goes for energy stocks like Exelon (NASDAQ: EXC) or NextEra Energy (NYSE: NEE), which provide fuel for transportation and heating. Other consumer goods that are considered defensive are household non-durable products like toothpaste and soap, which are produced by companies like Procter & Gamble (NYSE: PG) and Unilever (NYSE: UL).
While they may not deliver high returns, defensive are essential for long-term investment portfolios due to the fact they can still generate growth even amid the most volatile trading market. Popular defensive ETFs include the SPDR Utilities Select Sector Fund (NYSE: XLU) and Vanguard Consumer Staples (NYSE: VDC).
Trading Tactics
Investors have several different options in the way they choose to balance offensive and defensive stocks in their portfolios, but one of the easiest ways is to have a mix of each to counteract the continuously changing business cycle.
For a more conservative approach, an investor should build a portfolio consisting predominantly of non-cyclical stocks that would not need to rebalanced as often, generating slow and steady gains. For a more risky approach, an investor should load their stock portfolio with cyclical stocks when the economy is growing and unload them when the market is declining, a strategy that requires more attention and may carry heavy losses.