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  • 5 things to know about cyclical, defensive stocks

    You may have noticed that not all stocks move in tandem, especially when reacting to news about the economy. Almost always, a certain section of the stock market falls when the news is negative about the economy, while another bunch of stocks rise.

    This means there is a correlation between economic conditions and market movement. Understanding this connection could help you take better decisions in the stock market.

    Let's understand further:

  • Connection between economy and stocks:

    Let's first understand the reason for the correlation. When you buy a stock, you essentially buy a portion of the company. So, you have vested interest in the company's future growth and profits. Anything that affects the company positively is good news for shareholders. Also, if there is high likelihood that a company has a profitable future, then more would buy its stocks. This leads to a rise in its stock price. There are companies which are closely tied to the economy. Their profitability depends on whether or not the economy is booming. This is why, whenever there is any macro-economic data, certain stocks almost always respond.

  • Defensive, cyclical stocks:

    Depending on whether a company is more or less affected by economic trends, there are two types of stocks. The stocks of companies that are more closely linked to the economy are called cyclical stocks. Alternatively, the stocks of companies that are not affected by economic trends are called defensives.

  • Cyclicals and economic boom:

    Cyclical stocks are preferred when the economy is booming or when investors sense an economic turnaround is in the offing. During an economic boom, consumers tend to have more money to spend as improved corporate profitability leads to acceleration in salary growth, which in turn results in higher disposable income. So, they loosen their purse strings are purchase more goods, especially luxury products or goods that are not basic requirements. In contrast, these are first goods people stop buying during downturns, when they have less money in their pockets. The best examples are cars, new properties, or electronics like refrigerators or air-conditioners. This is why auto, realty, capital goods and consumer durable sector stocks are considered as cyclical. These stocks are also considered riskier - as their fortunes are prone to economic booms and busts.

  • Defensives during downturns:

    In contrast, whenever investors are worried about the economy, they opt for defensive stocks. This is because investors feel that these companies will be profitable even if the economy is not doing well. So, they are a safer bet than cyclical stocks. These companies often deal with goods which are basic necessities like food, medicines or even insurance. Even during tougher times, consumers can barely afford to cut down spending on these goods. This is why they are relatively unmoved by the economy.

  • Pharma and IT:

    In the Indian stock market, IT and pharmaceutical sector stocks are also considered as defensives. This is because Indian companies in these two sectors mainly cater to the American or European market. On a relative basis, these sectors have a large share of revenues coming from outside India. As a result, their profitability is not linked to the Indian economy. This is why, you may often see IT and pharma company stocks rally whenever investors are bearish about the Indian economy.

    • Learn about other types of stocks: Read more

    • Investors bet on defensives as earnings growth remains largely elusive  Read more

  • 325%

    The Indian economy has witnessed a slowdown the past couple of years. This is especially after a recession hit the US economy in 2008-09. The market has been quite volatile, especially between 2009 and 2014. During this time, the market often preferred defensives like IT and FMCG, which outperformed the 30-share BSE Sensex. In the four-year period between 2009 and 2013, the BSE's IT index jumped 325%, while the FMCG index rose 230%. This is much higher than the Sensex' 127% rise.