What Are Countercyclical Stocks?
Countercyclical stocks are stocks whose prices tend to move opposite to the overall business cycle. If the market is trending upward, countercyclicals will be trending down. Likewise, if the market is tanking, countercyclicals can be expected to be trending upward.
The How And Why of Countercyclical Stocks
Cyclical stocks—those with prices that generally match the overall business cycle—do well when the economy is booming. Their historical performance often directly correlates with the economic cycles of expansion, peak, recession, and recovery.
During periods of economic prosperity, car manufacturers, airlines, many retailers, and restaurants benefit from consumer discretionary spending. Conversely, when the economy contracts, consumers tighten their belts and cut back on their discretionary spending. People defer purchasing cars or taking vacations and they often reduce spending on clothes and eating out.
Countercyclical stocks, on the other hand, do well in periods of economic uncertainty and tend to underperform during peaks or periods of expansion. As you can imagine, a business that thrives when consumers are limiting their spending isn’t too common, but there are a few examples.
Discount retailers, alcohol brands, and other “last resort” businesses such as payday lenders are generally cited as the prime examples of countercyclical businesses.
Investing in Countercyclical Stocks
There isn’t universal agreement on exactly which stocks are classified as countercyclical. Savvy investors are always interested in protecting their portfolios in times of economic uncertainty, and stocks that generally perform better during recessions can seem particularly attractive for this purpose. As with any other investment strategy, there are a few things to take into consideration.
Timing the Market Is Risky
Armed with the knowledge that a particular stock does better during a recession, and with a recession on the horizon, we should load up on countercyclical stocks, right? Not so fast. In the same way that cyclical stocks can be beat up during protracted periods of economic contraction, the inverse is true in this case. If a market correction doesn’t produce a recession as expected, then you could be looking at some serious underperformance in your portfolio.
Additionally, the growth of a specific market sector is not always proportional to stock market growth. A small market upswing—particularly during a recession—can lead to an enormous market jump. Even though the market at large is falling, certain areas may experience surges, which could cause a countercyclical stock to underperform.
Countercyclicals Run Against the Grain
If the historical performance of the stock market has taught us anything, it’s that even the worst periods of economic contraction are temporary. The natural state of the stock market is one that tends toward growth. This means that we can expect more periods of economic prosperity than of economic uncertainty. A strong countercyclical stock must have enough cash on hand and a robust enough business to weather the peaks and periods of expansion if it is going to thrive when spending is tight.