The Implications of Stalled US Consumer Spending on Discretionary Retail and Consumer Cyclical Stocks

The US consumer spending landscape in 2025 is marked by a paradox: resilience in discretionary retail coexisting with growing pessimism about future economic conditions. While Gen Z and Millennials, now entering peak earning years, have driven a 2.6% increase in discretionary spending as of May 2025 according to JPMorgan research, broader trends suggest a slowdown. By November 2025, discretionary spending intentions had declined for the first time since June, with consumer confidence dropping sharply to 88.7, a 6.8-point decline as reported in Q3 2025. This duality underscores the fragility of the post-pandemic recovery, where sector rotation and earnings resilience are critical for investors navigating a slowing economy.

Sector Rotation: Shifting Alliances in a Fragmented Market

Sector rotation in Q4 2025 has highlighted a strategic pivot toward small-cap and value stocks, with consumer cyclicals benefiting from accommodative monetary policy and domestic economic growth according to Comerica's outlook. The Consumer Discretionary sector, rated "Marketperform" by Schwab according to Schwab's sector analysis, has seen mixed fortunes. While strong job growth and low interest rates have propped up spending on discretionary items, risks such as trade policy uncertainty and concentration risk-where the sector's two largest companies dominate nearly half its market cap-loom large as noted in Schwab's analysis.

The rotation into small-cap and value stocks is evident in the Russell 2000 and Russell Microcap indices, which surged over 12% and 17% in Q3 2025 according to Comerica's analysis. This shift reflects investor skepticism toward concentrated mega-cap growth stocks and a search for undervalued opportunities in sectors like apparel manufacturing as reported by Morningstar. However, the sector's exposure to tariffs and inflationary pressures complicates its outlook. For example, retailers like Walmart and Costco have outperformed with same-store sales gains of 3.8% and 5.7%, respectively as reported in Q3 2025, while mall-based chains like Target and Kohl's struggle with declining foot traffic.

Earnings Resilience: Winners and Losers in a Fragmented Sector

Earnings resilience in consumer cyclicals has been uneven, with subsectors diverging sharply. The Broadline Retail segment led Q3 2025 with a 34.8% earnings surge, driven by companies like Etsy (40.0%), Amazon (33.3%), and Olie's Bargain Outlet (28.4%) according to Q3 2025 retail data. These gains reflect a shift toward e-commerce and discount retail, as consumers prioritize affordability amid inflation. Conversely, the Household Durables sector faced a 20.0% earnings decline, with LGI Homes and La-Z Boy posting losses of 71.2% and 14.6%, respectively according to Q3 2025 retail data.

The divergence highlights the importance of operational agility. Companies that adapted to shifting demand-such as those leveraging AI-driven inventory management or expanding into international markets-have outperformed peers. For instance, the Federal Reserve's rate cuts in September 2025 as noted in Comerica's outlook and easing trade tensions provided a tailwind for small-cap and international stocks, with emerging markets gaining nearly 28% year-to-date according to Comerica's analysis. However, macroeconomic headwinds, including rising inflation and geopolitical tensions, have dampened demand for high-end services like luxury travel and dining as reported by Morningstar.

Strategic Implications for Investors

The interplay of sector rotation and earnings resilience suggests a nuanced approach for investors. While the broader market remains cautious-13 retailers issued negative preannouncements in Q4 2025 according to Q3 2025 retail data-opportunities exist in subsectors with strong pricing power and operational efficiency. For example, the outperformance of the Consumer Staples Distribution & Retail segment, led by United Natural Foods' 156.3% earnings growth according to Q3 2025 retail data, illustrates the potential of companies aligning with long-term trends like sustainability and health-conscious consumption.

However, the sector's vulnerability to policy shifts and inflationary pressures cannot be ignored. Tariffs, which have already depressed demand for discretionary services as reported by Morningstar, could further erode margins if global growth falters. Investors should prioritize companies with diversified supply chains and robust balance sheets to mitigate these risks.

Conclusion

The stalled US consumer spending growth in 2025 has created a bifurcated landscape for discretionary retail and consumer cyclical stocks. While sector rotation into small-cap and value stocks offers short-term opportunities, the long-term outlook hinges on macroeconomic stability and corporate adaptability. As the Federal Reserve's policy pivot and trade tensions evolve, investors must remain agile, favoring subsectors with earnings resilience and strategic differentiation. In this environment, the key to success lies not in chasing broad trends but in identifying companies that can navigate the fragility of the post-pandemic economy.