Cyclicality is often misunderstood as a trading tool. In reality, it's an important fundamental concept
17-May-2021 •Dhirendra Kumar
I once knew someone who discussed cyclical stocks with me and then sent me a mail about them in which he spelled them as 'psychlicals'. I smiled at the time but now I think he might have been on to something. There are way too many investors (traders?) who attribute near-psychic abilities to cyclical stocks and the very idea of cyclicality.
There are several variations to the idea of cyclicality and what exactly one means by it. There is a broad idea of business cycles, which may or may not be true but should be of interest only to economists and economic historians. The theory of business cycles essentially says that there are long periods of relative contraction and expansion around mean economic growth. However, there are so many other non-cyclical events that overlay these long-period cycles that the idea has no practical use whatsoever.
At the other extreme is the punter who has reduced the idea of cyclicality to the trite level of technical analysis and other such mumbo jumbo. They'll look at the chart of a stock and there will be an up and down cycle of sorts and they'll say 'cyclical!' or rather 'psychlical!' and look for the up part of the so-called cycle. This is NOT what a cyclical stock is. Except for stocks that are on a one-way fall, there are always ups and downs in every price graph at some scale. If you zoom the price graph in or out to some appropriate scale, you can always find this and call it a cycle or a psychle.
That's not a cycle, not at all. Read our cover story of the month 'How to profit from cyclicals' and understand the difference between psychlical and cyclical. What cyclical stocks really are, whether and under what conditions they are useful for investors and just as importantly, when they are not useful. These stocks are cyclical because of the fundamental nature of their business and how it interacts with the rest of the economy. Just as important, you can understand the differences between cyclical stocks and other non-cyclical stocks and how they all play a role in your investment portfolio and in helping you meet your financial goals.
There is no doubt that understanding cyclical stocks is an important part of the toolkit of every investor. This importance could be positive or negative, in the sense that you may well conclude - as our cover story explains - that this is a tactical tool and it just does not suit your style of investing and the kind of investor you are. I empathise with that point of view and must confess that it's not far from what I believe in personally. However, unlike fictional concepts like technical analysis, cyclicals and non-cyclicals are a fundamental concept that investors should be knowledgeable about.
However, I'll make one more important point about such concepts by pointing out that top-down ways of understanding markets must finally be subject to a bottom-up analysis of actual companies. You can read any amount of theory about concepts but to quote my favourite philosopher, Nassim Nicholas Taleb, "It's much easier to bullshit at the macro level than it is to bullshit at the micro level." That's his inimitable voice explaining why bottom-up is way better than top-down. Bottom-up is reality while top-down could just be talk. A concept is just a concept. Finally, does it help you identify actual stocks and the actual actions to take with those stocks? Does it make money for you? That's where the rubber hits the road and that's what we hope to help you do in our analysis.
This editorial appeared in Wealth Insight May 2021 issue. To read the cover story and other insightful analyses, columns and articles