The Retail Slowdown: Navigating Defensive Plays Amid a Shifting Consumer Landscape

MarketPulseTuesday, Jun 17, 2025 10:20 pm ET
120min read

The U.S. retail sector's 0.9% month-over-month sales decline in May 2025, announced by the Commerce Department, marks a pivotal shift in consumer behavior. This drop—driven by steep declines in auto sales ahead of Trump-era tariffs and weaker demand in home goods and groceries—signals a broader slowdown in discretionary spending. For investors, this data underscores the need to reassess sector allocations, favoring defensive industries like utilities and healthcare while tempering exposure to consumer discretionary stocks. Below, we dissect the implications for portfolios and tactical shifts.

The May Retail Sales Decline: A Sector-Specific Wake-Up Call

The May sales drop was not uniform. Auto sales fell sharply as consumers front-loaded purchases in March to avoid 25% tariffs on imported vehicles. Even excluding autos, retail sales still declined by 0.3%, with home and garden centers plummeting 2.7% and electronics stores down 0.6%. Meanwhile, resilient sectors like online retailers (+0.9%), clothing (+0.8%), and furniture (+1.2%) offered modest bright spots.

This divergence highlights a structural shift: consumers are prioritizing essentials and discount-driven purchases over big-ticket discretionary items.

Fed Policies, Inflation, and Consumer Debt: The Macro Backdrop

The Federal Reserve's rate hikes since 2022 have cooled inflation to 2.5% (PCE measure), but they've also tightened consumer budgets. While low unemployment (3.4% in May) supports baseline spending, consumer confidence has declined for three straight months, per the LSEG/Ipsos index, reflecting anxiety over job markets and inflation.

Key metrics to watch:
- Debt levels: Auto loan delinquencies rose 12% in Q1 2025, signaling vulnerability in credit-sensitive sectors.
- Inflation trends: Core PCE (excluding energy/food) remains sticky at 3.6%, complicating Fed policy.

The Fed's pause on further rate hikes since July 2024 has provided some relief, but real disposable income growth remains sluggish at 1.2% annually—ahead of inflation but insufficient to drive robust spending.

Sector ETF Performance: A Tale of Two Markets

The May retail data amplifies trends already visible in sector ETFs. Let's compare key indices:

Consumer Discretionary (XLY): Vulnerable to Tariffs and Sentiment

  • YTD Performance (as of April 2025): -11.8% (NAV), trailing the S&P 500.
  • Top Risks: Heavy exposure to tech-driven companies like Amazon (-15% YTD) and auto retailers.
  • Outperformers: Off-price retailers (e.g., TJX Companies) rose 3% in Q1, benefiting from value-seeking shoppers.

Utilities (XLU): A Steady Anchor

  • YTD Return (May 2025): +5.0%, with a 2.84% 30-day SEC yield.
  • Defensive Edge: Utilities' stable demand for electricity/gas insulates them from retail cycles.
  • Policy Play: Low interest rates (10-year Treasury at 3.4%) favor rate-sensitive utilities.

Healthcare (XLV): Mixed Signals Amid Stability

  • YTD Return (May 2025): -3.1%, dragged down by biotech volatility.
  • Bullish Case: Strong earnings growth (StarMine estimates suggest 7% surprises in pharma) and aging demographics boost demand for essential services.
  • Underlying Strength: Utilities and healthcare ETFs outperformed the S&P 500 by 8% in Q1, per analysts.

Tactical Portfolio Shifts: Prioritize Resilience

  1. Reduce Exposure to XLY:
  2. Why: Tariffs, declining auto sales, and weak home goods demand will persist.

  3. Action: Trim positions in retailers like Target (-25% YTD) and focus on off-price plays (TJX) or consumer staples.

  4. Increase Utilities (XLU) Allocations:

  5. Why: Utilities' 5.0% YTD return and 2.84% yield make them a hedge against volatility.

  6. Focus: Diversify into multi-utility firms (e.g., Southern Co., XLU's top holding) with stable dividends.

  7. Monitor Healthcare (XLV) for Bottoming:

  8. Why: While XLV underperformed in Q1, its defensive role and 9.93% EPS growth estimates justify a long-term hold.

  9. Pick: Overweight pharmaceuticals (Eli Lilly, AbbVie) over volatile biotech stocks.

  10. Avoid Tech and Consumer Cyclicals:

  11. Why: Sectors like semiconductors (XLK) fell 15% YTD amid weak demand for discretionary electronics.

Expert Forecasts and Risks to Watch

Analysts like Thomas Hayes of Great Hill Capital project utilities and healthcare to outperform in 2025, citing their low beta and earnings stability. However, risks remain:
- Tariff Rollbacks: If auto tariffs are eased, discretionary sectors could rebound—though political gridlock makes this unlikely.
- Inflation Surprise: A spike in core PCE above 4% could force the Fed to raise rates again, hurting rate-sensitive utilities.

Conclusion: Rebalance Toward Defensives—But Stay Alert

The May retail decline is a clarion call to pivot portfolios away from discretionary spending and toward utilities and healthcare. While defensive sectors offer stability, investors should remain nimble: monitor June's retail data for confirmation of the slowdown, and track Fed policy shifts. For now, the playbook is clear: favor XLU and XLV, trim XLY, and avoid cyclical bets—until the consumer's resilience becomes clearer.

JR Research's analysis underscores that in uncertain times, resilience beats speculation.