Mad Money

The Importance of Secular Vs. Cyclical

Investors need to learn the language of investing if they’re going to make any sort of profits in the market, Jim Cramer said Wednesday on CNBC's "Mad Money." To help out, he dedicated the show to explaining that jargon. Think of it as a Wall Street-to-English dictionary of sorts.

First up: cyclical versus secular stocks. A company is cyclical if it needs a strong economy in order to perform well. Its fortune depends on the business cycle. Steelmakers like Nucor , machinery firms like Caterpillar and chemical companies like DuPont all fall into this category.

(RELATED: Cramer's Top Dividend Stocks)

Secular, on the other hand, refers to companies whose growth remains consistent regardless of the economy. Typically they are manufacturers of foods, drinks, drugs and cigarettes. Some of the most recognizable household brands probably come to mind: General Mills , Coca-Cola , Procter & Gamble . These are classic recession-proof stocks that you to want own when the economy takes a dive because no one stops eating or brushing their teeth just because of a recession.

But why are these two groups important? A couple of reasons, actually. First, knowing whether a company is cyclical or not will help you determine its earnings. Second, the investing strategy employed by all money managers is based on when to buy cyclicals or seculars depending on how the world’s economies are doing at any given moment. (The move back and forth between one and the other is called “rotation,” another term worth knowing.) And these are the guys who virtually set the market’s share prices for the short term.

Plus, about 50 percent of the performance of any individual stock comes from its sector—tech, health care, energy, etc. And when it comes to sectors, much of their moves are driven by whether they are either cyclical or secular.

Given these explanations, the right way to trade these stocks is probably obvious. Steer clear of cyclicals when the economy’s tanking; pile into them when it’s revving up. The opposite is true for seculars. You want the protection these steady earners offer when the business environment is weak, but they won’t do your portfolio much good during the boom times.

Of course, this doesn’t mean you should be constantly rotating back and forth. If anything, Cramer endorses diversification. Spread your risk out among multiple sectors, allocating about 20 percent of your portfolio to each different kind of stock you own. That way you won’t take too hard a hit if a rotation takes down your cyclicals. Those secular stocks will be there to hedge any potential losses.

Cramer’s bottom line: “Know the difference between cyclical and secular,” he said, “recognize a sector rotation when you see one, and always stay diversified.”

(Written by Tom Brennan; Edited by Drew Sandholm)

When this story was published, Cramer's charitable trust owned Coca-Cola and DuPont.

Call Cramer: 1-800-743-CNBC

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