U.S. Retail Inventories Ex Auto: Sector Rotation and Strategic Opportunities Amid Inventory Shortfalls

The U.S. retail landscape in 2025 is marked by a stark divergence in sector performance, driven by inventory shortfalls and shifting demand patterns. While consumer discretionary sectors grapple with overstocking and declining residential demand, the Transportation Infrastructure and Building Materials sectors are emerging as relative outperformers. This dynamic underscores a critical opportunity for investors to recalibrate portfolios in response to evolving macroeconomic conditions.

Inventory Shortfalls and Sector Divergence

The latest U.S. Retail Inventories Ex Auto data reveals a marginal 0.1% decline in June 2025, following a modest 0.2% increase in May. This volatility reflects broader challenges in the retail sector, particularly in the Distributors segment. Single-family home starts have fallen 14% year-over-year to 940,000 units, driven by high mortgage rates and macroeconomic uncertainty. Distributors, especially those reliant on residential construction, are struggling with inventory overhangs and input cost volatility. For example, GMS Inc., a wallboard distributor, saw its stock plummet nearly 12% in May 2025 before a potential acquisition bid sparked a 36% rebound.

In contrast, the Building Materials sector is gaining traction. Infrastructure spending, automation, and commercial construction activity—particularly in data centers and logistics hubs—are driving demand for steel, copper, and concrete. Sustainability trends further bolster this sector, with recycled aluminum projected to meet 71% of construction demand by 2050. This structural shift positions Building Materials as a long-term growth driver, even amid retail inventory shortfalls.

Historical Context and Sector Rotation

Historical data reveals a recurring pattern: during major retail inventory shortfalls, such as the -2.10% decline in December 2008, the S&P 500 Transportation sub-index underperformed due to economic downturns. However, 2025 marks a reversal. The S&P 500 Materials index (MATR) has outperformed the Consumer Discretionary index (COND) in recent quarters, with projected annualized growth of 4.2% for Building Materials versus 1.8% for Distributors. This divergence is fueled by infrastructure spending and automation, which are insulating the sector from traditional cyclical pressures.

Strategic Implications for Investors

The current environment demands a tactical reallocation of assets. Here's how investors can navigate the shifting landscape:

1. Underweight Consumer Discretionary Sectors: Distributors face headwinds from inventory overstocking and declining residential demand. Companies reliant on single-family construction or retail segments with high overstock risks should be avoided. Instead, focus on firms with robust inventory management systems and diversified exposure to commercial markets.

2. Overweight Transportation Infrastructure and Building Materials: These sectors are benefiting from structural demand drivers. Prioritize companies with exposure to infrastructure spending, automation, and sustainable materials. Firms demonstrating strong cash flow generation and pricing power in a tightening supply chain are particularly attractive.

3. Monitor Tariff and Interest Rate Risks: The Trump Administration's fluctuating tariff policies and potential rate cuts in 2026 could reshape sector dynamics. Distributors with international supply chains should be scrutinized for vulnerability to trade policy shifts, while Building Materials firms with domestic sourcing advantages may gain a competitive edge.

Backtested Insights and Tactical Adjustments

Backtesting historical performance during retail inventory shortfalls provides further clarity. From 2010–2023, the COND index outperformed MATR with an average annual return of 22.4% versus 13.9%. However, 2024–2025 marks a turning point, with MATR outperforming COND in Q1 2025. This reversal highlights the importance of adapting to structural shifts rather than relying on historical trends.

Conclusion

The U.S. retail inventory landscape in 2025 reflects a broader economic transformation. While consumer discretionary sectors face headwinds, Transportation Infrastructure and Building Materials are emerging as resilient growth engines. By underweighting vulnerable Distributors and overweighting sectors aligned with infrastructure and sustainability, investors can capitalize on divergent trajectories. As the year progresses, continued monitoring of inventory trends, tariff policies, and interest rate expectations will be critical to maintaining a balanced and forward-looking portfolio.