Cyclicals Bear the Brunt of Volatility

By Greg Woodhams - October 24, 2018

Another day, another volatile trading session amid worries about trade, geopolitical tension and slowing global growth. Though we've been talking about these issues for weeks, corporate earnings season is helping to bring them into focus.

Industrials were among the hardest hit in Tuesday's trading, highlighted by Caterpillar and 3M, which disappointed analysts with their guidance on future earnings. Profits at both companies—and industrials broadly—are under pressure as inflation and tariffs push their costs higher. Companies in the economically sensitive materials sector also fell. More defensive areas, such as consumer staples and communications services sectors were positive.

In the late stages of an economic cycle, costs rise as resources, supply chains and labor pools are stressed. This is an incremental headwind for profit growth, even when sales are growing. Cyclical companies have significant exposure to these late-cycle pressures since a greater portion of their costs are subject to inflation. In contrast, they don't face the same pressures in the early stages of an economic cycle.

Investors are reluctant to pay a premium for earnings that may not be sustained if the economy slows or falls into recession. And, since it's difficult to accurately predict the beginning of a recession, cyclical stocks may begin lag long before it arrives.

Companies exhibiting secular growth, on the other hand, may benefit from underlying competitive advantages that are not dependent on the economic cycle. Therefore, strong secular growth companies may outperform later in the cycle due to expectations their earnings growth can continue even as the economy slows.

While we aren't predicting a recession here, the Federal Reserve has made a clear statement that the economy has moved beyond the accommodation phase. This implies we have moved into the late stage of the economic cycle. Shifts like this bring volatility.

Investors should view the volatility of recent weeks as normal, rather than as an aberration. At the same time, they should take the long view and use these periods to align their portfolios with their risk tolerance and investment time horizons.

Greg Woodhams
Global Growth Equity
  • Related Articles
  • More From Author

Fed Commits to Help for the Long Haul

Here’s the role the Federal Reserve has played in the 2020 economy, and what policymakers are expecting for the rest of the year.

Finding Opportunities in an Overlooked Asset Class

Asset-backed securities can be an attractive asset class just slightly off the traditional bond investor's beaten path. Learn whether they deserve an allocation in your fixed income portfolio.

3 Potential Market Disruptors No One is Talking About, Yet

Liquidity, volatility and credit spreads may all have a role to play in the year ahead, according to Head of Investment Solutions Cleo Chang.

    The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.

    Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.

    References to specific securities are for illustrative purposes only, and are not intended as recommendations to purchase or sell securities. Opinions and estimates offered constitute our judgment and, along with other portfolio data, are subject to change without notice.