The performance of cyclical stocks is heavily dependent on the economic cycle – they do well when the economy is booming but very badly when it falls off a cliff. A classic example would be housebuilders, all of whom have done well in the UK over the last ten years in a benign environment of low interest rates and high demand. However, when the economy falters, as interest rates and unemployment rise, these shares all take a battering, whether the underlying building company is good or bad.
Counter-cyclical (or ‘defensive‘) stocks, such as utility and tobacco companies, tend to perform consistently whether the economy is doing well or badly. This is largely because they supply a product which is regarded as a staple – people who smoke do so in good and bad times – demand for which is not highly correlated with the state of the broader economy.
A balanced portfolio should contain a mixture of cyclical and non-cyclical stocks which can be altered as the economic climate changes.
• See Tim Bennett’s video tutorial: What are defensive stocks?