Counter-Cyclical Stock: What it is, How it Works, Risks

What Is a Counter-Cyclical Stock?

A counter-cyclical stock refer to the shares of a company that belongs to an industry or niche with financial performance that is typically negatively correlated to the overall state of the economy. As a result, the stock's price will also tend to move in a direction that is opposite to the general economic trend, meaning appreciation occurs during times of recession and depreciations in value occur in times of economic expansion.

This may be contrasted with a cyclical stock.

Understanding Counter-Cyclical Stocks

Increasingly, it is harder for a company's operations to become counter-cyclical because it is fairly difficult to find a business model that thrives in a period where most people do not have money. Outplacement agency stocks, for example, would be considered counter-cyclical, because these companies help laid-off workers find jobs in exchange for a fee. This type of company would be more successful during times of recession, because there would be more unemployed workers at that point in time compared to times of expansion. Purchasing counter-cyclical stocks can serve as a good hedge to the standard recessionary pressures that can cause most stocks to decline.

Not as many investors think of counter-cyclical stocks when considering their investing possibilities. Also, there is always total agreement on which companies and industries can be classified as counter-cyclical. However, those that get usually mentioned include alcohol-related companies and discount retailers, and as desperate times might lead more people to desperate measures, investors can now invest in the uptick in crime that accompanies a sour economy as many prisons are now operated by for-profit corporations.

Counter-cyclical industries can suffer greatly during economic expansions (which can last for years). Such companies may even be prone to bankruptcy if they don't have the cash on hand or strong balance sheets to weather a long economic expansion. Investors attracted to stocks in counter-cyclical industries are faced with the arduous task of trying to time the market—that is, to predict where the bottom of the business cycle is in order to sell at the optimal time and then predict where the top of the cycle is in order to buy at the optimal time. This can be hard, given the fact that some countercyclical stocks start sliding before a recovery has actually begun.

Risks of Investing in Counter-Cyclical Stocks

Investing heavily in counter-cyclical stocks carries risks that come from the complexities of the stock market system. If, for example, it appears that the market is headed for a big recession, there are some potential issues to think about before immediately reallocating assets into counter-cyclical stocks or other securities. One potential issue is that market growth is not always proportional to stock market growth; a tiny market upswing, particularly during a recession, can lead to an enormous market jump. Because of this, while the whole market may be falling, certain areas may experience surges, which might cause counter-cyclical stocks to underperform.