The Resilience and Risks of the US Consumer in a Tariff-Driven World

The U.S. retail landscape in Q2 2025 reveals a stark dichotomy: while essential goods thrive, discretionary sectors falter under the weight of tariffs and inflation. This divergence underscores a critical question for investors: Can the current retail sales growth sustain itself in a world where trade policies and macroeconomic forces increasingly dictate consumer behavior?

The Resilience of Consumer Staples

Consumer Staples, encompassing groceries and health products, have emerged as a defensive haven. Grocery sales surged 5.42% year-over-year, while health and personal care products rose 6.5%, driven by households prioritizing essentials amid inflation. The Control Group—a metric excluding volatile categories like autos and gasoline—posted a 0.5% month-over-month gain in June 2025, reinforcing the sector's resilience. However, this growth masks margin pressures: tariffs on imported goods have eroded profit margins, with 78% of retailers citing tariffs as a material earnings drag.

The sector's strength is rooted in necessity. As wages stagnate and prices rise, consumers are shifting spending toward non-discretionary items. For example, Costco and Walmart reported robust same-store sales (SSS) growth, while mall-based retailers like Kohl's saw a -5.0% SSS decline. This trend aligns with historical patterns: when the U-6 unemployment rate (including underemployment) drops, Consumer Staples typically underperform cyclical sectors. Yet, with U-6 at 8.3% in July 2025, the labor market's improvement may soon tilt investor sentiment toward infrastructure and energy.

The Fragility of Cyclical Sectors

In contrast, the Building Materials sector faces headwinds. Sales at building material and garden equipment dealers fell 2.7% in May 2025, reflecting a housing market slowdown and trade policy uncertainty. While a 0.9% rebound in June offered temporary relief, the sector remains vulnerable to high interest rates and weak wage growth. This underperformance contrasts sharply with the 2022 infrastructure boom, when the Bipartisan Infrastructure Law spurred a $550 billion construction surge.

The Textiles, Apparel & Luxury Goods sector fared even worse, with projected earnings declines of -41.4%. Nike and G-III reported sharp drops, highlighting the vulnerability of discretionary spending. Tariffs on imported goods—particularly in furniture, sporting goods, and clothing—have exacerbated these challenges, forcing retailers to reconfigure supply chains. Target, for instance, reduced China sourcing from 60% in 2017 to 30% by Q1 2025, a trend likely to accelerate.

Tariffs and Inflation: A Double-Edged Sword

Tariffs have become a defining feature of the retail environment. While they protect domestic industries in the short term, their long-term costs are mounting. Producer Price Index (PPI) data for July 2025 showed a 3.3% annual increase—the largest since February 2025—driven by sticky services inflation. Businesses are passing these costs to consumers, with real food services spending declining 0.7% in Q2.

The inflationary impact is uneven. Tariff-sensitive categories like furniture and sporting goods saw July 2025 sales gains, while electronics and apparel struggled. This fragmentation complicates forecasting, as consumer demand shifts toward value-driven goods. Discount retailers like Walmart and Costco have capitalized on this trend, but mall-based chains face existential challenges.

Investment Implications

The data points to a strategic reallocation of capital. Historical trends suggest that when the U-6 rate declines by more than 0.5% quarter-over-quarter, Building Materials and Energy sectors outperform the S&P 500 by 12% annually, while Consumer Staples underperform by 3%. With U-6 at 8.3% in July 2025, cyclical sectors like infrastructure and energy appear poised for growth. ETFs such as the iShares U.S. Home Construction ETF (ITB) and SPDR S&P Homebuilders ETF (XHB) have gained 9% year-to-date in 2025, while Consumer Staples ETFs like XLP have declined 13.9% in 2024.

Investors should also monitor the interplay between tariffs and inflation. While tariffs may provide short-term tailwinds for domestic manufacturers, their inflationary effects could force the Federal Reserve to maintain higher interest rates longer than anticipated. This dynamic favors high-dividend energy stocks with pricing power, such as ExxonMobil (XOM) and Chevron (CVX), over sectors with thin margins.

Conclusion

The U.S. consumer remains resilient but is navigating a complex landscape. Consumer Staples will likely continue to outperform in the near term, but the long-term sustainability of this growth depends on how tariffs and inflation evolve. Cyclical sectors like Building Materials and Energy offer compelling opportunities as the labor market improves and infrastructure spending accelerates. However, investors must remain vigilant: the same tariffs that protect domestic industries today could fuel inflationary pressures tomorrow.

In a tariff-driven world, the key to success lies in balancing defensive plays with cyclical bets—and in recognizing that the most enduring investments are those that adapt to shifting macroeconomic realities.