Cyclical stocks are stocks whose fortunes rise and fall as part of a larger business cycle. They are affected by the overall state of the economy and the demand for their goods or services. Generally, cyclical stocks consist of businesses within industries such as automobiles, airlines, leisure & hospitality, oil & gas, and consumer durables.

When there is a receding economy, these industries that are largely tied to consumer spending are the most vulnerable. Businesses in these industries don’t produce as much and consequently, the stock prices suffer. When the economy is booming, these industries typically benefit from greater consumer spending, resulting in increased profits, which are reflected in the stock prices.

Because of their higher levels of volatility, cyclical stocks can generate significantly higher returns during periods of economic prosperity. Historically, the performance of cyclical stocks has outpaced that of the market, especially during economic upswing. During times of economic recession, however, cyclical stocks tend to underperform the broader market.

Investors looking to take advantage of cyclical stocks as part of their portfolio should consider the fact that they will be less diversified, due to their dependence on the economy. Therefore, it is important that investors understand the risks of investing in cyclical stocks.

The rewards of investing in cyclical stocks can be significant if an investor has the patience and an understanding of the company and industry fundamentals. But, before investing in cyclical stocks, investors should do an extensive research on the companies they are interested in, understand the nature of their products and services, their competitive advantages, and how they’re positioned in the current market. Looking at key indicators of the industry and macroeconomic factors can also help investors determine if the short-term market opportunities are in line with their investment objectives.