8 Factors that drive Cyclical Industry

— 3 minutes read—

Cyclical Industry is an industry that is sensitive to the business cycle of an economy.

The revenues from the industry are generally higher in periods of economic prosperity and expansion.

So a cyclical industry is highly correlated to the economic activity.

Few examples of cyclical industries are cement, construction, steel, capital goods, among others.

Thus, from the above examples, it is clear that these sectors are directly linked to economic growth or tends to see an indirect income effect emanating from shifts in economic growth.

Cyclical sectors and their stocks surge when the economy is in an uptrend and these are exactly the types of sectors that should be avoided when the economy is weak.

Influences on Cyclical Industry

1.Gross Domestic Product (GDP)

Cyclical industries are directly impacted by the economy’s overall performance, which is measured by the GDP, a measurement of economic output.

The rise in GDP indicates that the economy is growing leading to higher employment rate and thus higher disposable income, leading people to increase their spending for various purposes.

It also indicates a rise in government spending on infrastructure and allied activities.

This leads to stocks of sectors like cement, steel, telecommunication, technology and capital goods produce higher returns.

Few of the companies in these segments are Larsen & Toubro, Tata Steel, Ambuja Cement, Bharti Airtel, Tata Consultancy Services, Havells, Bharat Electronics and others.

2. Consumer spending levels

This has a major influence on the cyclical industry and its stocks.

This can be gauged by tracking COI (Consumer Confidence Index) which provide insight on how much people are saving as compared to how much they are spending and the overall sentiment that is ruling the market.

In other words, it measures how optimistic or pessimistic consumers are about the economy’s current and future performance.

When the index is high, consumers are expected to increase their spending on goods and services. Thus, the stocks of cyclical industries surges.

When the index is low, a decrease in spending is expected. Thus, the stocks of cyclical industries head southwards.

That is why, stocks of companies like Maruti Suzuki India, Titan, Whirlpool, Indian Hotels usually sees a surge when the index performs well.

3. Indicators

As we know that the performance of the cyclical sector is directly related to the performance of the economy.

Growth in the economy results in robust performance of cyclical stocks.

So, there are various indicators that help gauge the overall performance of the economy.

Few of which are as follows:

• PMI (Purchasing Managers’ Index ): This measures the health of the manufacturing sector. An index value above 50% indicates a positive development in the industrial sector, whereas a value below 50% indicates a negative situation.

• IIP (Index of Industrial Production)– This indicator shows the growth rates in different industry groups of the economy in a stipulated period of time. Index of Industrial Production basically provides a general idea about how is the level of industrial activity in the economy.

• CPI (Consumer Price Index)– It is the principal indicator of the prices of goods and services which indicates whether the economy is experiencing inflation, deflation or stagflation.

Along with the above, other indicators affecting cyclical are Interest rates, rural growth and energy prices which can impact GDP growth.

When the indicators show positive sentiment means that the GDP of the economy is growing and in turn the cyclical stocks will produce strong returns.

Aspects that drive the Cyclical stocks performance and price:

• The beta of the stock – The first is the Beta value or systemic risk. Cyclicals tend to have high beta values, which are usually higher than 1. A beta of 1.5 means if the market falls 10 %, the stock is likely to fall 15 per cent.

• Earnings Per Share – Cyclical stocks tend to have volatile earnings per share or EPS, as their earnings keep on fluctuating in relation to the sentiment in the economy.

• Price – Earnings Ratio – Cyclical generally tend to have low PE ratios, making them cheaper in comparison to defensive stocks.

The bottom line is that cyclical industry is largely dependent on economic growth. When the combination of investment and growth is in their favor, the stocks of the cyclical industry can give steady returns in a very short period. This makes the stocks of cyclical industry critical from portfolio point of view.