The Reawakening Consumer: How Receding Inflation Expectations Signal a Turning Point for Retail and Cyclical Sectors

The U.S. consumer, long the engine of economic growth, is showing signs of reawakening. After months of cautious pessimism, the latest data from the University of Michigan and the Conference Board suggests a subtle but meaningful shift: inflation expectations are moderating, and consumer sentiment, while still fragile, is trending upward. This pivot, however incremental, could signal a pivotal moment for cyclical sectors that have languished under the weight of elevated uncertainty. For investors, the question is no longer if these sectors will recover, but how to position for a market where retail, travel, and discretionary spending regain their luster.

The Economic Climate: A Cautious Optimism

Consumer sentiment in July 2025 reached 61.7, a modest increase from June and the highest level since February. While this remains 7.1% below December's post-election peak, the Current Economic Conditions index hit 68.0, its highest in five months. This suggests that households are beginning to perceive stability in their immediate financial environments, even as long-term expectations remain clouded. Meanwhile, inflation expectations have continued their downward trajectory: one-year expectations fell to 4.5%, and five-year expectations to 3.4%, both the lowest since early 2025. These metrics, though still above the Federal Reserve's 2% target, indicate that the worst of the inflationary shock may be receding.

The Federal Reserve's policy pivot, with rate cuts anticipated in December, adds further context. While the Fed's preferred inflation metric (PCE) remains stubbornly above 3%, the market is pricing in a 50–75 basis point easing by year-end. This combination of moderating inflation, a resilient labor market (despite a 4.2% unemployment rate), and a political climate that has yet to fully materialize into a tariff-driven recession creates a fertile ground for cyclical sectors to outperform.

The Cyclical Sector Opportunity

The Morningstar US Consumer Cyclical Index, which had underperformed the broader market by nearly 10% year-to-date through July 25, 2025, now appears poised for a correction. The sector's decline reflects a mix of macroeconomic headwinds and overcorrection by investors who have fled to safer assets. Yet within this underperformance lie opportunities.

Consider the case of Hanesbrands (HBI), whose stock trades at just 28% of Morningstar's fair value estimate. The company's vertically integrated manufacturing model insulates it from many of the supply chain risks that have plagued its peers. With a narrow economic moat and a strategic focus on debt reduction, Hanesbrands is well-positioned to capitalize on a rebound in consumer demand for basics, particularly as inflationary pressures ease.

Similarly, JD.com (JD), the Chinese e-commerce giant with a wide economic moat, has seen its stock fall to 47% of fair value. Its asset-heavy logistics network and expanding into food delivery and on-demand services position it to benefit from shifting consumer preferences toward convenience and premium experiences. While geopolitical risks and China's economic slowdown remain concerns, the company's margin expansion and digital transformation efforts suggest a path to long-term growth.

Strategic Plays: Balancing Risk and Reward

The key to capitalizing on this turning point lies in identifying companies that are both undervalued and structurally positioned to benefit from a shift in consumer behavior. For example, CarMax (KMX), a leader in the used car retail sector, trades at 51% of fair value. Its omnichannel strategy and focus on customer-centric innovation (e.g., digital financing tools) align with the growing preference for seamless, low-hassle transactions. Meanwhile, Bath & Body Works (BBWI), trading at 52% of fair value, is expanding into higher-margin categories like haircare and men's grooming, leveraging its strong brand equity to capture a broader demographic.

However, not all cyclical stocks are created equal. Companies like Kohl's (KSS) and Capri Holdings (CPRI) remain vulnerable to macroeconomic shocks. Kohl's struggles with e-commerce competition and shifting retail dynamics, while Capri's reliance on luxury brands (Michael Kors, Versace) exposes it to volatile consumer spending in premium segments. These names require a more cautious approach, with a focus on structural reforms rather than speculative bets.

The Road Ahead: Policy Uncertainty and Portfolio Resilience

The path to recovery is not without risks. The looming implementation of new tariffs, combined with potential immigration policy shifts, could reignite inflationary pressures or strain labor markets. Yet, the data suggests these risks are priced into the market. The yield curve's gradual normalization and the Fed's anticipated rate cuts in December provide a buffer against near-term volatility.

For investors, the priority is to build portfolios that balance exposure to cyclical sectors with defensive plays. Treasury Inflation-Protected Securities (TIPS) and gold, for instance, remain essential hedges against stagflationary risks. Yet, the current discount in consumer cyclical stocks—many of which trade at 40–50% of fair value—offers a compelling asymmetry: limited downside in a scenario of continued economic resilience, and significant upside if consumer spending accelerates.

Conclusion: The Time to Act

The reawakening consumer is not a sudden surge but a gradual thaw. As inflation expectations stabilize and the Fed's policy pivot takes hold, cyclical sectors will likely outperform in the coming quarters. The challenge for investors is to distinguish between companies that can navigate this transition and those that are relics of a bygone era.

The data is clear: the market has priced in the worst-case scenarios. Now, it's time to look beyond the headlines and invest in the fundamentals. For those willing to do so, the undervalued cyclical stocks highlighted here—Hanesbrands, JD.com, CarMax, and Bath & Body Works—offer a unique opportunity to capitalize on the next phase of the economic cycle. As the consumer regains confidence, these names could well be the ones that deliver outsized returns.