Cyclical stocks are shares in companies which are sensitive to the wider economy — generally becoming very profitable when markets are booming and falling sharply when the financial environment weakens.

Understanding cyclical stocks

In other words, cyclicals are subject to elastic demand — if consumers view a company’s product or service as a discretionary purchase, then this will be the first thing cut from the budget in difficult times. Conversely, when consumers have excess income, cyclical stocks tend to get a boost. Good examples of cyclical companies include airlines, hotels, restaurants, auto manufacturers and luxury goods producers.

The opposite of cyclical stocks (non-cyclical) are defensive stocks, which are shares in companies where demand for their services or products remains constant regardless of economic conditions. These include utilities, tobacco and grocery companies; many investors in cyclical companies also include some defensive stocks in their portfolio as a hedge against economic weakness.

There are some important points to consider before investing in cyclical stocks. For example, they are far more volatile than the average share on the market — identifiable by higher-than-average beta values and often lower price-to-equity ratios as the market needs to factor in the risk that past income earnt is not a reliable bellwether for future performance.

This volatility is also compounded because cyclicals tend to attract short-term traders, who seek to go long on cyclical shares at the bottom of the cycle and go short when they feel a cyclical company has reached its zenith. Of course, this is also a common investing strategy — but timing the market is a difficult skill to master.

Best cyclical stocks to watch

These five shares are the five largest cyclical companies on the FTSE 100 by market capitalisation. There is an element of subjectivity to the list, however, as the line between cyclicals and defensives is not clear-cut.

1. Shell
2. BP
3. Rio Tinto
4. Diageo
5. Glencore

Shell

Often the largest company on the FTSE 100, and in a constant battle with defensive AstraZeneca for the top spot, oil major Shell is widely considered to be cyclical because it derives the vast majority of its revenue from exploring, producing and selling oil and gas on the global markets.

Oil and gas are cyclical because demand for hydrocarbons is inextricably tied into global economic performance; the better the global economy is performing, the higher the demand for the products. Of course, the global economy can also overheat with inflation, which reduces consumer demand and can cause oil and gas to fall.

In Q1 2024 results, adjusted earnings came in at $7.7 billion, reflecting strong operational performance business wide. The major also announced a new $3.5 billion share buyback programme, and noted that the cash capex outlook for 2024 remains unchanged at between $22 billion and $25 billion.

CEO Wael Sawan enthused that ‘ Shell delivered another quarter of strong operational and financial performance, demonstrating our continued focus on delivering more value with less emissions.’

BP

The second FTSE 100 oil major, BP benefits and suffers from many of the same macroeconomic factors as Shell. Importantly, just like Shell it is beholden to global economic demand and not UK-based economics.

For context, the stock sank when the world entered into global lockdown cycles during the pandemic, and rocketed when Russia invaded Ukraine as the former was subjected to significant economic sanctions.

The major remains significantly profitable, but has been through some tumultuous changes, including the undignified exit of former CEO Bernard Looney, shareholder disagreements over its green transition policies, and the base reality that it has arguably underperformed compared to Shell over the past few years.

In Q1 2024 results, BP saw a reported profit of $2.3 billion, announced a 7.27 cent per ordinary share quarterly dividend — and launched a $1.75 billion share buyback to be completed before Q2 results.

CEO Murray Auchincloss noted that ‘Oil production was up and our ACE platform in the Caspian is now producing. We are simplifying and reducing complexity across bp and plan to deliver at least $2 billion of cash cost savings by the end of 2026.’

Rio Tinto

Rio Tinto is one of the largest mining companies in the world, responsible for unearthing and processing metals and critical minerals including its famous Pilbara iron ore blend, aluminium and copper that are essential for day-to-day life. However, the company is dependent on the prices it can fetch for its metals — which itself is dependent on a strong global economy, particularly in China.

The multi-commodity nature of the business makes it perhaps less volatile than a single commodity producer, but at the same time it’s also perhaps harder to know where Rio Tinto shares will go as the different markets for its metals are subject to different pressures.

In Q1 2024 production results, CEO Jakob Stausholm enthused that ‘we navigated seasonal challenges across our global operations. Our full year guidance is unchanged across all our products. We remained focused on growth in energy-transition materials, with the ramp-up at Oyu Tolgoi underground, the first full quarter of recycled aluminium production from Matalco and further progress at Simandou, our high grade iron ore project in Guinea.’

Diageo

Diageo is one of the largest producers of alcoholic beverages in the world, selling its wares across 180 countries to discerning consumers all over the world. The company owns more than 200 brands, including many familiar names such as Johnnie Walker, Guinness, Smirnoff, Baileys and Captain Morgan.

It also spends significant capital on developing new brands to continue to meet changing consumer tastes. While alcohol is itself widely viewed as a defensive product category, Diageo’s focus on the premium segment makes it vulnerable to weak consumer sentiment during downturns, and a popular stock when the global economy is surging.

In Q1 2024 results, net sales declined by 1.4% year-over-year to $11 billion due to an unfavourable forex impact and a 23% decline in Latin America and the Caribbean.

CEO Debra Crew advised that ‘the first half of fiscal 24 was challenging for Diageo and our sector, particularly as we lapped strong growth in the prior year and faced an uneven global consumer environment…we have taken action and have further plans to reduce inventory to more appropriate levels for the current consumer environment in the region by the end of fiscal 24. This is a key priority.’

Glencore

Similar to Rio Tinto, Glencore is a major mining corporation, which also acts as one of the largest commodities traders in the world — buying and selling everything from metals to soft commodities. It’s also well-known as a large recycler of various metals including cobalt and copper — and is involved in over 60 different commodities.

This level of diversification protects Glencore from individual commodity pricing bumps, but it is still closely tied to market factors as commodity pricing as a whole is dictated by global demand.

In preliminary 2023 full-year results, CEO Gary Nagle noted that ‘our Marketing and Industrial segments posted a lower, albeit healthy, earnings performance in 2023, delivering Group Adjusted EBITDA of $17.1 billion, cash generated by operating activities of $15.1 billion and Net income attributable to equity holders of $4.3 billion.’