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Countercyclical stocks usually refer to stocks that move in opposition to the market. They are important in achieving a diversified portfolio, as they help balance out earnings in any type of market. Countercyclical stocks tend to exist for specific economic reasons or due to certain company policies.
Some countercyclical stocks do comparatively well in falling or low markets because of demand requirements that do not alter. For instance, regardless of the stock market, food or medicine demands remain relatively stable. Investing in food stocks during an economic downturn will probably still result in some profit, as their stability is nearly assured by a constant demand. These stocks are also considered non-cyclical due to their consistent stability, but can be useful in countercyclical investment plans as a defensive strategy.
Some companies are designed to perform better during bad economic periods. Temp agencies will often experience a significant boost in business during a downturn, as large companies fire employees in order to save money or reduce in size. Contrarily, in times of economic expansion, temp agencies will usually lose business, as large companies are hiring more full-time workers. Other agencies that benefit from economic recessions can include bankruptcy firms and attorneys.
The risk to investing heavily in countercyclical stocks comes from the complexities of the stock market system. If it appears that the market is headed for an enormous recession, it would automatically seem wise to invest in countercyclical companies, however, there are some potential issues in this strategy. For example, 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 and cause countercyclical stocks to underperform.
Another risk is in assuming that just because a company is countercyclical, it is going to do well in a recession as compared to other similar companies. It is still important to research the past performance and policies of any company you purchase stock from. If it is a badly run organization with a history of failures, better, lower-priced companies in the same vein will probably outperform it.
Despite these risks, investing in countercyclical stocks is an excellent way to diversify your stock portfolio. By ensuring that some of your investments perform well in rising markets and some in falling markets, you will hopefully achieve a balanced portfolio that makes money no matter what happens. This method of covering your bets with countercyclical investments is a good defensive strategy for a beginning investor, so long as they do careful research and prepare for the inherent risks of the stock market game.