Inflation Crossroads: Why Utilities Outperform Airlines in a Low-Inflation Era

The June 2025 U.S. CPI report confirmed a modest inflation uptick, with core inflation holding steady at 2.9%. Yet beneath the headline numbers lies a critical divergence: sectors like passenger airlines and gas utilities are reacting starkly differently to the economic environment. For investors, this divergence offers a clear roadmap for sector rotation. Let's dissect how these industries are positioned—and why utilities now deserve a premium in portfolios.

The Airlines Dilemma: Overcapacity and Demand Shifts

The Consumer Discretionary sector, particularly airlines, is under sustained pressure. The June CPI report highlighted a 7.3% annual decline in airline fares since May 2024, with monthly declines accelerating to 2.7-2.8% in recent months. This reflects a perfect storm of overcapacity, shifting consumer preferences, and tariff-driven cost pressures. For instance:- Tariff impacts: While tariffs on Chinese goods have increased prices broadly, airlines face indirect costs from higher fuel prices and supply chain disruptions. - Demand erosion: Las Vegas passenger traffic fell 7.5% year-over-year in February , while Canadian travelers cut visits to U.S. destinations. - Structural shifts: Post-pandemic travel patterns favor leisure over business, but even leisure demand is slowing as consumers prioritize spending elsewhere.

The backtest data underscores this trend: airlines and travel-related stocks (e.g., cruise lines, casinos) have underperformed the broader market for two consecutive years. The S&P 500 Consumer Discretionary sector fell 17.8% year-to-date through April 2025, dragged down by giants like Tesla (-37.1%) and Amazon (-18.1%).

Utilities: A Safe Harbor in Volatile Markets

Utilities, by contrast, are proving resilient. The June CPI showed gas service prices rising 15.3% annually, while electricity climbed 4.5%, even as broader energy prices fell. This divergence highlights utilities' unique cost drivers—regulatory mandates, infrastructure investments, and inelastic demand. Key trends:- Stable earnings: Utilities are one of only two sectors with rising Q2 2025 earnings estimates (+0.3% Y/Y). - Defensive profile: Utilities' forward P/E multiples remain lower than cyclicals, offering a cushion against economic slowdowns. - Regulatory tailwinds: Gas utilities often pass rising supply costs directly to consumers, insulating margins.

Historical backtests validate this outperformance: during low-inflation periods (CPI < 3%), utilities have outperformed consumer discretionary by an average of 12% annually since 2015.

Why Rotate Now? Fed Policy and Inflation Risks

The Federal Reserve's stance reinforces the case for utilities. Despite holding rates at 4.25%-4.50%, the Fed's July 2025 meeting emphasized “data dependence.” With core inflation near 3%, the risk of further rate hikes is low—but so is the likelihood of immediate cuts. This “wait-and-see” approach favors stable-yielding sectors like utilities.

Meanwhile, airlines face compounding headwinds:- Tariff-driven costs: Even as goods inflation eases, airlines' input costs (e.g., fuel, maintenance) remain volatile. - Structural overhang: The sector's YTD decline of 14.2% (hotels, resorts, and cruises sub-sector) suggests investors are pricing in prolonged weakness.

Actionable Recommendations

1. Rotate out of consumer discretionary: Reduce exposure to airlines, casinos, and luxury retailers. Sell losers like Delta Air Lines (DAL) or Las Vegas Sands (LVS) and rebalance into cash or utilities.
2. Build utility positions: Target NextEra Energy (NEE), Dominion Energy (D), or Sempra Energy (SRE) for stable dividends and inflation-hedging. Utilities like these have 90%+ dividend payout consistency over the past decade.
3. Monitor CPI components: Track shelter costs (a key CPI driver) and energy prices. A further drop in shelter inflation could accelerate utilities' outperformance.

Conclusion

The CPI data paints a clear picture: low inflation is here to stay, and sector dynamics are widening. Airlines face a losing battle against overcapacity and shifting demand, while utilities thrive in this environment. Investors who pivot toward defensive, regulated sectors now will be positioned to weather volatility and capitalize on the next phase of the economic cycle.

Data as of July 14, 2025. Past performance does not guarantee future results. Always consult a financial advisor before making investment decisions.