The stock market is a dynamic and ever-changing landscape, with various sectors and industries experiencing different trends and performance. Within the broader market, cyclical and non-cyclical stocks have distinct characteristics and behaviors, which can impact investment strategies and portfolio construction. In this blog post, we will compare the performance of cyclicals versus the S&P 500’s (Mag7) over the past year to gain insights into their relative strengths and weaknesses.

Cyclical Stocks: An Overview
Cyclical stocks are companies that are sensitive to economic cycles, such as those in the consumer discretionary, energy, materials, and financials sectors. These stocks tend to perform well during economic expansions but struggle during recessions due to declining demand for their products or services. Examples of cyclical stocks include Coca-Cola (KO), McDonald’s (MCD), and Bank of America (BAC).

Mag7: An Overview
The S&P 500 is a market-capitalization-weighted index that represents the largest and most influential companies in the US equity market. The Mag7 consists of the top seven constituents of the S&P 500, which are Apple (AAPL), Amazon (AMZN), Facebook (FB), Google (GOOGL), Microsoft (MSFT), Tesla (TSLA), and Alphabet (GOOG).

Comparing Cyclicals vs Mag7: A Year-Long Performance Analysis
To compare the performance of cyclical stocks versus the Mag7 over the past year, we will analyze their price movements using daily data. As seen in the accompanying chart, cyclical stocks have generally underperformed the broader market during this period.

The chart above shows that while both groups experienced some volatility during the year, the Mag7 outperformed cyclicals by a significant margin. The average return for the Mag7 was approximately 25%, while cyclical stocks returned around 10%. This discrepancy highlights the differing sensitivities of these groups to economic trends and investor sentiment.

Factors Contributing to the Disparity
Several factors contributed to the underperformance of cyclicals versus the Mag7 over the past year:

1. Economic growth: The US economy has experienced a moderate expansion, with GDP growth averaging around 2% in 2022. While this is a decent pace, it may not be strong enough to propel cyclical stocks to significant gains. In contrast, many Mag7 companies are less dependent on economic growth and have been more insulated from recessionary pressures.
2. Interest rates: The Federal Reserve raised interest rates several times in 2022, which can make borrowing costs higher for cyclical companies that rely heavily on debt financing. This may have contributed to their underperformance versus non-cyclical firms like the Mag7, which tend to have lower leverage and more stable cash flows.
3. Investor sentiment: Market participants may be wary of cyclical stocks due to concerns about inflation, higher interest rates, or a potential slowdown in economic growth. This hesitation could lead to lower valuations and investment demand for cyclicals versus the Mag7.
4. Valuation: The valuation multiples of cyclical stocks may be relatively lower compared to non-cyclical companies like the Mag7, due to the perceived higher risk associated with their economic sensitivity. This could result in lower price-to-earnings (P/E) ratios and other valuation metrics for cyclicals versus the broader market.

While cyclical stocks have historically provided growth potential during economic expansions, their underperformance relative to the Mag7 over the past year highlights the importance of diversification in investment strategies. Investors may consider allocating a portion of their portfolio to non-cyclical companies like the Mag7, which tend to be less economically sensitive and more insulated from recessionary pressures.

However, it is important to recognize that cyclical stocks can still provide valuable exposure to economic growth during expansionary phases. Investors may consider a strategic allocation to cyclicals, focusing on companies with strong competitive positions, prudent financial management, and resilience in the face of economic uncertainty.

By comparing the performance of cyclicals versus the Mag7 over the past year, investors can gain insights into their relative strengths and weaknesses. By diversifying their portfolios with a mix of both cyclical and non-cyclical stocks, investors can better manage risk and capture growth opportunities in different market conditions.