BANKING & FINANCE: Stocks that weather different economic climates
If you’re an investor, you know that the stock market offers the potential to help your portfolio grow and reach your long-term financial goals. But what do you do during times of market volatility? Are there stocks that tend to perform better during turbulent economic times? What types of stocks should you own when market and economic conditions improve?
Two types of stocks that react differently to economic conditions are defensive and cyclical stocks. Defensive stocks generally offer more stability and hold up better during economic downturns than cyclical stocks, which tend to move up and down with, or modestly ahead of, economic conditions. Of course, past performance is not a guarantee of future results.
Defensive stocks typically outperform in a slowing economic recession. These are typically stocks of companies that provide necessities like food, utilities, pharmaceuticals, toiletries or other consumer products with a short shelf life.
The theory is that consumers will continue to buy necessities like food and address their medical needs regardless of economic conditions. As a result, companies that sell these types of products should not be as negatively affected by a slowing economy as companies that produce more discretionary types of products.
On the other hand, cyclical stocks can produce favorable results if you invest in them at the right time in the economic cycle. The value of a cyclical stock is tied closely to the condition of the economy. If investors anticipate a slowing economy, the price of a cyclical stock tends to rise. Cyclical stocks are stocks of companies that produce goods, such as automobiles, or provide services such as leisure travel and lodging.
Consumers will typically not spend discretionary dollars on goods and services like these when the economy is likely to slow and job security becomes a concern. As a result, the earnings of companies manufacturing these types of products are more vulnerable during uncertain economic times.
Many stocks are neither purely defensive nor purely cyclical, but they have characteristics of both. For example, it is hard to predict how a large retailer that sells a variety of consumer goods, including clothing, house wares, electronics and grocery products, will react during different market conditions.
Discretionary items like house wares and electronics would be considered highly cyclical, while grocery products would normally fall into the defensive products that individuals will buy no matter what the economic environment.
If your portfolio is overweighted with defensive stocks, you might not be getting the best return on your investment in a growing economy.
Conversely, if your portfolio is too heavily weighted with cyclical stocks, you will probably be taking on more risk than you expected in an economic downturn.
Your financial consultant can help you determine whether a stock is defensive or cyclical. The key is to build a balanced, diversified portfolio that addresses your individual long-term investing goals, time horizon and risk tolerance.
Article provided by A.G. Edwards & Sons Inc. Member SIPC. Reach Karmin Grace at 946-1630. BN