Rising Core PCE Inflation Triggers Shift to Infrastructure Plays

The June 2025 Core Personal Consumption Expenditures (PCE) inflation print of 3.5%—exceeding forecasts and marking the highest year-over-year rate since late 2022—has reignited concerns about persistent inflationary pressures. For investors, this surprise underscores the need to reassess sector allocations, particularly as Federal Reserve officials signal a renewed focus on curbing price growth. In this environment, Construction & Engineering stocks emerge as a tactical overweight opportunity, positioned to benefit from inflation-driven infrastructure spending while offering a hedge against Fed tightening cycles.

The Inflation Surprise and Its Implications

The 3.5% Core PCE print, which exceeded the Federal Open Market Committee's (FOMC) median projection of 3.1% for 2025, reflects a confluence of factors: lingering supply-chain frictions, rising labor costs, and the delayed impact of tariff hikes. While the Fed's preferred measure excludes volatile food and energy prices, the core metric's upward drift has pushed policymakers to acknowledge a broader inflation risk. This uncertainty has fueled speculation about further rate hikes, even as the Fed's June projections hinted at a pause.

The inflation surprise has also exposed a critical divergence in market performance: consumer discretionary stocks, which rely on robust consumer spending, have faltered as real incomes erode, while Construction & Engineering firms have shown resilience. This divergence is no accident. Infrastructure spending—driven by government stimulus, corporate capital expenditures, and private-sector demand for modernization—tends to thrive when inflation is sticky, as companies and governments prioritize projects to offset rising costs.

Sector Rotation: From Consumption to Construction

The historical playbook for inflation-driven sector rotation is clear. During periods of persistent inflation, investors have traditionally shifted from consumer discretionary (which faces margin pressure) to sectors insulated by pricing power or tied to inflation-linked spending. The Construction & Engineering sector fits both criteria:

1. Inflation-Linked Contracts: Many infrastructure projects are structured with cost-of-living adjustments or fixed-price contracts that allow firms to pass through rising material and labor costs.
2. Government Backstops: Fiscal stimulus packages, such as the 2022 Bipartisan Infrastructure Law and state-level bond issuances, are accelerating demand for transportation, energy, and water projects.
3. Corporate Capex Surge: Companies in energy, utilities, and manufacturing are ramping up spending to modernize facilities and comply with regulatory standards, further boosting demand for engineering services.

Historical backtests of this strategy are compelling. During the 1970s stagflation, construction stocks outperformed the S&P 500 by over 20% annually, while consumer discretionary stocks lagged. Similarly, during the late 2000s inflation spike, construction firms rose 35% versus the S&P 500's 15% gain.

Current Opportunities and Risks

Today's landscape mirrors these historical patterns. The 3.5% Core PCE print has already spurred policymakers to accelerate infrastructure approvals. For example, the Biden administration's National Climate Advisor recently announced a $50 billion package for grid modernization, while state governments are prioritizing bridge and highway repairs.

Investors should focus on firms with exposure to public-private partnerships (PPPs), energy transition projects, and urban infrastructure. Key metrics to monitor include:
- Infrastructure spending as a % of GDP: The U.S. lags peers at 2.3%, per the American Society of Civil Engineers, leaving ample room for growth.
- Construction unemployment: A tight labor market (currently 4.1% in construction) signals demand outpacing supply.
- Material costs: Steel and cement prices, while elevated, remain manageable due to long-term contracts.

Risks to the Thesis

The strategy is not without risks. A sharp economic slowdown could delay project timelines, while higher interest rates might curb private-sector capex. However, the Fed's “data-dependent” stance and the bipartisan appeal of infrastructure spending mitigate these risks.

Investment Strategy

For tactical allocation, overweight Construction & Engineering ETFs such as iShares U.S. Construction Producers (ITB) or sector leaders like Fluor Corp. (FLR) and AECOM (ACM). Pair this with an underweight in consumer discretionary names like Amazon (AMZN) or Target (TGT), which face margin compression from inflation.

Conclusion

The 3.5% Core PCE surprise has shifted the investment narrative from “reflation trade” to “infrastructure pivot.” With governments and corporations prioritizing projects that can absorb rising costs, Construction & Engineering stocks are positioned to outperform in an inflationary environment. History and current fundamentals support this sector rotation—making it a prudent hedge against both Fed tightening and prolonged price pressures.

Data sources: Bureau of Economic Analysis, Federal Reserve Economic Data (FRED), FOMC Summary of Economic Projections, American Society of Civil Engineers.