Stock market's consumer sectors are ‘unfavorable' after lagging S&P 500 earnings growth

The Wells Fargo Investment Institute has designated U.S. consumer sectors "unfavorable," as Q2 earnings for consumer staples and discretionary lagged the S&P 500, with these sectors significantly underperforming the broader index year-to-date due to tariff uncertainties. Companies like Walmart are absorbing tariff-related costs to maintain prices, and Wells Fargo forecasts that tariffs will ultimately constrain household spending into late 2025 and early 2026, a sentiment supported by the Fed's Beige Book noting flat consumer spending and economic uncertainty. Despite these headwinds for consumer-facing businesses, the S&P 500 has continued to climb, buoyed by strong performance from Big Tech.

Analysis

The U.S. consumer staples and consumer discretionary sectors are facing significant headwinds, warranting the 'unfavorable' rating assigned by the Wells Fargo Investment Institute. This view is substantiated by both fundamental performance and market data; in Q2, both sectors lagged the S&P 500's year-over-year earnings growth, and their year-to-date stock performance of 4.1% and 3.7% respectively, drastically underperforms the S&P 500's 10.4% gain. The core issue stems from tariff-related uncertainties, which are directly impacting corporate profitability and consumer behavior. Walmart (WMT) serves as a prime example, with its shares slumping 4.5% after a Q2 profit miss attributed to absorbing tariff costs to keep prices low—a clear indicator of margin pressure. This micro-level stress is echoed by macro-level data from the Fed's Beige Book, which noted 'flat to declining consumer spending' and cited tariffs as a negative factor. While Wells Fargo has revised its 2025 U.S. economic growth forecast upward, it anticipates that tariffs will ultimately 'constrain households and limit spending' into late 2025 and early 2026, suggesting a prolonged period of pressure. This presents a notable market divergence, where the S&P 500 index approaches record highs, buoyed by outsized gains in Big Tech, while the broader consumer-facing economy shows signs of strain.

Key Decisions for Investors

• Consider an underweight allocation to broad consumer staples and discretionary ETFs, as persistent tariff headwinds and lagging earnings growth suggest continued underperformance relative to the S&P 500.
• Scrutinize individual company earnings within consumer sectors for evidence of margin compression, as the ability to pass on or absorb higher costs, highlighted by Walmart's recent profit miss, will likely be a key performance differentiator.
• Monitor leading economic indicators for consumer health, such as retail sales and wage growth, as the Fed's Beige Book and Wells Fargo's forecast point to a potential slowdown in household spending that could intensify.
• Recognize that headline index strength is being narrowly driven by Big Tech, and be cautious of this divergence masking fundamental weakness in the more cyclically-sensitive, consumer-dependent segments of the market.