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Long Story Short: Why Should One Invest in Consumer Cyclicals?
Everything from A-to-Z: There are Consumer Cyclical Stocks for Everyone
The consumer cyclical sector includes a broad range of companies all the way from automotive to travel and leisure. Their stocks’ performance relies on the business cycle and the current economic state. When the economy is strong and consumers have a larger disposable income, spending in these industries increases and the performance reflects in the stock price. On the other hand, when the economy contracts and consumers have less disposable income, spending on entertainment and luxuries shrinks. Remember also that company performance depends on the niche that it fills; smallcap companies in this sector are affected by the same economic conditions and business cycles as largecaps. Regarding investing, many internal and external factors must be considered when selecting the right companies for your portfolio.
Thrives in a healthy economy. When the economic conditions are favorable, companies in the consumer cyclical sector tend to do well. Both low interest rates and low unemployment usually contribute to a healthy economy, which leads to increased spending on items such as cars, entertainment, and vacations. The increase in sales and company revenue often result in a positive return on investment within this sector.
Some pay dividends. For an investor with limited capital, knowing the consumer cyclical sector is heavily swayed by economic conditions that are not always stable or predicable, consumer cyclicals may not seem like a good option. However, with stock picking, investors can focus on the ones that pay a dividend, so even in times of economic downturn, the dividend can help cushion the fall. Many largecap companies in this sector pay dividends, but some smallcap ones do as well.
ETFs to gain exposure. A popular way to invest in consumer cyclicals is through ETFs. Many ETFs are composed of smallcap companies, such as the PSCD Invesco S&P SmallCap Consumer Discretionary ETF. ETFs offer a more balanced investment, and this ETF in particular is geared toward those with a long investment horizon. Regarding smallcap companies in consumer cyclicals, long-term strategies are typically advised because of the fluctuation in economic conditions. A smaller or a newer company in this sector may not have had the chance to brace for the fluctuations yet, so no one knows how that company will perform. A long-term hold allows the investor to see how the company reacts.
Deteriorates with a falling market. Unfavorable market conditions have a negative impact on consumer discretionary spending. High unemployment, inflation, and other negative conditions often reduce the average consumer’s disposable income. When the economy begins to slow down, sales decline and earnings take a hit, which later reflects in the stock price.
Shifting demand trends. As technology advances and trends fade, companies classified as consumer cyclicals must stay in tune with these changes. Although, not all companies are able to keep up with changing conditions. Many see a downturn for multiple quarters until they are finally brought up to speed. Common examples are traditional bookstores, record shops, and print media companies. Smallcap companies with traditional storefronts and business models have a larger downturn when trends shift.
Physically fading. Many traditional retailers are facing challenges with the increase of online sales. Consumers can find nearly everything they need online, from the comfort of their homes. From electronics to groceries, products and produce can be delivered right to their doorstep, which has created a problem for many retailers who are seeing their in-store sales decline. Many newer companies, especially smallcaps, have an online presence only. The cost and risk of opening a physical location does not seem to come with much benefit in retail. Many large companies have closed locations due to declining sales.
As the market fluctuates and economic policies change, consumer cyclicals rise and fall with these conditions. The companies in this sector tend to perform strongly when the economy is healthy. Steady and favorable economic conditions increase consumer confidence, leading to increased discretionary spending. However, many of these established companies are struggling to keep up with the shifting demand trends. Technology is evolving and phasing out places like traditional bookstores, since e-books can easily be purchased from a home computer or smartphone. Emerging smallcap companies have an advantage over many traditional retailers; they can make their mark with the newest technology and focus on what is trending without burning capital on physical locations or other diminishing factors.
https://www.investopedia.com/terms/c/consumer_cyclicals.asp, Will Kenton May 7, 2019
https://www.fool.com/investing/how-to-invest-in-consumer-discretionary-stocks.aspx, Demitrios Kalogeropoulos August 13, 2019
https://www.schwab.com/resource-center/insights/content/consumer-discretionary-sector, Brad Sorensen August 29, 2019