The Resilience of U.S. Consumer Spending Amid a Softening Labor Market

The U.S. consumer has long been the backbone of economic growth, but 2025 has tested its mettle. Despite a labor market in retreat—marked by downward revisions to job gains, rising layoffs, and a participation rate near a decade low—retail sales data reveals a surprising resilience. This dichotomy between a cooling labor market and stubborn consumer spending underscores a critical question: Can structural shifts in retail demand and evolving consumer behavior sustain earnings for consumer-facing equities in a macroeconomic headwind?

Retail Sales: Resilience in a Time of Uncertainty

Q2 2025 retail sales data paints a mixed but telling picture. While July's retail sales grew by a modest 0.5% (below forecasts), sales per square foot rose 4.2% year-over-year, a metric that has surged 45% above 2019 levels. This productivity gain reflects a shift in how consumers allocate their dollars.

The retail sector's ability to absorb closures of underperforming stores—driven by bankruptcies like those in subprime retail areas—has not dampened demand. Instead, consumers are channeling spending into high-quality, essential, and digitally enabled experiences. For example, Walmart's 4.5% comp sales growth in Q2 2025 was fueled by its omnichannel strategy, including one-hour delivery and AI-driven inventory management. Conversely, traditional models like Target's in-store sales declined 5.7%, signaling a structural reorientation toward convenience and efficiency.

The data also highlights a shift toward budget-conscious spending. Consumer Staples (groceries, health products) grew 5–6% YoY, while discretionary categories like building materials and luxury goods lagged. This trend aligns with wage growth outpacing inflation by 140 basis points, but not enough to offset rising costs. Consumers are trading down—opting for private-label brands, secondhand goods, and value-conscious travel—while maintaining spending on essentials.

Labor Market Weakness: A Looming Overhang

The labor market's deterioration, however, casts a shadow over this resilience. Revisions to Q2 2025 job data revealed a net loss of 258,000 jobs in May and June, with July's additions (73,000) far below expectations. The unemployment rate rose to 4.2%, while the broader U-6 rate hit 8.3%, the highest since 2021.

This softening has two key implications for consumer-facing equities:
1. Earnings Sustainability: While wage growth remains a buffer, it is not immune to a prolonged labor slowdown. Lower-income consumers, who make up a significant portion of retail demand, are more vulnerable to job cuts and reduced hours. Morgan Stanley forecasts a deceleration in nominal consumer spending to 3.7% in 2025, down from 5.7% in 2024.
2. Credit Risk: Rising delinquencies and the potential for higher defaults—particularly among lower-income households—could strain consumer credit markets. While defaults remain below historical averages, the risk of deterioration is real, especially as tariffs and inflation erode purchasing power.

Valuation Divergence: Opportunities and Pitfalls

The consumer discretionary sector's valuation landscape is polarized. Elevated EV/EBITDA multiples (17.41 as of June 2025) reflect lingering optimism, but structural challenges—tariffs, supply chain risks, and shifting demand—have created mispricings.

Undervalued Opportunities:
- SpartanNash (SPTN): Trading at a P/S ratio of 0.09 and EV/EBITDA of 7.1, this regional grocery distributor offers a compelling entry point. Its 4.4% shareholder yield and focus on budget-conscious consumers align with long-term trends.
- United Natural Foods (UNFI): With a P/S ratio of 0.05 and a P/B of 1.02, UNFI is positioned to benefit from the organic food boom, a category showing 6–7% annual growth.

Risks to Watch:
- Tariff-Driven Inflation: The sector tops S&P Global's risk analysis for Q2 2025, with 30 credit rating downgrades and a median default probability of 2.95%. Companies like Best Buy and General Motors have already cut earnings guidance due to tariff costs.
- Valuation Multiples: While some subsectors trade at discounts, others—like luxury goods—remain overvalued. Investors must avoid extrapolating past performance in a structurally different environment.

Strategic Entry Points: Balancing Caution and Opportunity

For investors, the key lies in selectivity. The consumer discretionary sector is not a monolith; companies with strong unit economics, digital innovation, and geographic diversification are better positioned to weather macroeconomic turbulence.

• Cyclical Overweights: If the Federal Reserve cuts rates in September 2025, sectors like travel and leisure could outperform. However, this depends on a moderation in inflation and a stabilization of the labor market.
• Defensive Plays: Consumer Staples (e.g., SpartanNash) and essential services (e.g., healthcare retail) offer downside protection. These categories are less sensitive to job cuts and more resilient to inflation.
• Avoiding Overexposure: High-multiple discretionary stocks (e.g., luxury brands) remain vulnerable to a prolonged labor slowdown. Diversification across income segments and geographies is critical.

Conclusion: A Market in Transition

The U.S. retail landscape is in a transitional phase, shaped by digitalization, labor-saving investments, and evolving consumer behavior. While the labor market's softening poses risks, the underlying strength of retail space productivity and wage growth suggests that consumer spending will remain a pillar of economic resilience.

For investors, the challenge is to identify companies that are adapting to these shifts—those leveraging AI, optimizing supply chains, and catering to budget-conscious demand. The current valuation dispersion offers opportunities, but patience and discipline will be rewarded. As the Federal Reserve navigates its next rate move and tariffs reshape trade dynamics, the consumer discretionary sector will remain a barometer of both economic health and corporate adaptability.