Navigating Weak U.S. Consumption: Sector-Specific Strategies for a Shifting Economic Landscape

The U.S. economy is currently navigating a period of modest but uneven growth, as highlighted by the Q2 2025 Real Personal Consumption Expenditures (PCE) report. While headline and core PCE prices rose by 2.6% and 2.8% annually, respectively, the underlying trends reveal a nuanced picture. Consumer spending is increasingly skewed toward services—a sector now accounting for 66% of total PCE—while goods-driven industries face structural headwinds. This shift underscores the need for investors to adopt sector-specific strategies that align with the realities of a consumption-driven economy.

The Resilience of Defensive Sectors

Historical data and recent performance confirm that consumer staples remain a cornerstone of defensive investing during consumption slumps. The sector's focus on essentials—packaged food, household products, and personal care items—ensures stable demand even in weak economic conditions. For example, the Consumer Staples Select Sector SPDR ETF (XLP) and Vanguard Consumer Staples ETF (VDC) have historically outperformed during recessions, with XLP's 10-year annualized return of 10.92% (as of Q2 2025) reflecting its resilience. Companies like Procter & Gamble and Walmart, which dominate these ETFs, benefit from brand loyalty and recurring demand.

The healthcare and utilities sectors also offer defensive appeal. Healthcare's demand is inelastic, driven by aging demographics and technological advancements in pharmaceuticals and medical devices. Similarly, utilities provide steady dividends and low volatility, making them ideal for capital preservation. The Utilities Select Sector SPDR ETF (XLU) has delivered a 10.05% annualized return over the past decade, outperforming cyclical peers during downturns.

Cyclical Sectors at Risk

In contrast, sectors tied to discretionary spending and industrial activity are underperforming. The automobile and industrial goods sectors, for instance, have shown marked declines during consumption slumps. In Q2 2025, the S&P 500 Automobiles sector lagged the broader market by 8.3% following a contraction in the Chicago PMI. This reflects the sensitivity of durable goods to economic uncertainty, as consumers delay major purchases like cars and appliances.

The construction and engineering sector faces similar challenges. The S&P 500 Construction & Engineering Index has underperformed due to weak consumer confidence and reduced investment in long-term projects. Meanwhile, service sectors like travel and hospitality—though part of the broader services category in PCE—remain vulnerable to shifts in consumer behavior, such as the post-pandemic decline in leisure travel.

Strategic Allocation: Balancing Risk and Return

Investors should consider a dual approach to sector allocation: overweighting defensive sectors while underweighting cyclical ones. For example:
- Defensive ETFs: XLP, VDC, and XLU offer exposure to stable, high-dividend sectors.
- Cyclical ETFs to Avoid: The iShares U.S. Auto Manufacturers ETF (IYM) and SPDR S&P Homebuilders ETF (XHB) are likely to underperform in a weak consumption environment.

However, opportunities exist within cyclical sectors for those willing to take a contrarian approach. The semiconductor industry, for instance, has shown resilience despite broader economic volatility. The VanEck Semiconductor ETF (SMH) has delivered a 28.67% annualized return over the past decade, driven by demand for AI and cloud computing. While semiconductors are inherently cyclical, their long-term growth trajectory makes them a compelling addition to a diversified portfolio.

The Role of Policy and Market Timing

The Federal Reserve's decision to hold interest rates steady in 2025 has created a mixed environment. While low rates support borrowing for durable goods, they also prolong uncertainty in sectors like real estate and industrials. Investors should monitor the Fed's inflation-targeting framework and adjust allocations accordingly. For instance, a rate hike in late 2025 could further pressure cyclical sectors, while a pause might provide a temporary reprieve.

Conclusion: A Sector-Driven Path Forward

As U.S. consumption continues to shift toward services and away from goods, investors must recalibrate their strategies to reflect these structural changes. Defensive sectors like consumer staples, healthcare, and utilities offer stability, while semiconductors and AI-driven industries present growth opportunities. By avoiding overexposure to underperforming sectors and leveraging low-volatility ETFs, investors can navigate the current economic landscape with both caution and confidence.

In a world where economic cycles are increasingly unpredictable, sector-specific strategies remain one of the most effective tools for balancing risk and return. The key lies in aligning portfolio allocations with macroeconomic signals—such as PCE trends and Fed policy—while staying attuned to the evolving demands of the consumer.