Could the second half of 2025 be better for the US consumer?

While on the surface this is potentially significant cause for concern for the world’s most important consuming group, the hard data has yet to demonstrate any true fissure in behaviour. Retail sales have been surprisingly resilient (even after adjusting for a pull-forward in spending in March due to looming tariffs), consumer credit has remained on solid footing, and perhaps most telling is that first-quarter earnings commentary for many companies indicated a willingness to spend.

To wit, 35% of Consumer Discretionary management teams in the S&P 500 characterized their customers as either mildly strong or strong, with a further 10% describing their consumers as Stable. Across the smaller market cap, Consumer Discretionary companies in the S&P 600, over 40% of customers were characterized as mildly strong to strong, and a much higher 30% characterized as stable.

Of course, the caveat to this half-full glass on consumer spending is the lingering threat of tariff escalation. As it pertains to consumer equities, the fear is that the tariffs placed on goods sourced outside of the US will break the price elasticity of demand and companies will have to choose between higher sales and higher profits. We have long argued that companies with differentiated and superior products and services will have the pricing power to pass through these incremental costs and thus protect margins along the way - but to what end?

Following several years of improving merchandise margins due to leverage in freight costs, labour cost improvements resulting from wage growth deceleration, and efficiencies gained from technological advancements, many companies are at or near record-level profits. At a time when consumers are more cognizant than ever of price increases and are increasingly seeking value, the superior strategy could very well be to seek market share gains through a more cautious pricing strategy.

The first quarter earnings season forced the hand of many company management teams when it came to incorporating these “taxes” in their full-year outlook. We found that the strategy surrounding guidance for the year fell generally into three camps: not embedding the implied tariff costs - as they are yet unknown; embedding some level of tariff implications - as best as could be predicted at the time; or to pull guidance for the year due to heightened uncertainty. 55% of S&P 500 Consumer Discretionary companies embedded tariffs in their guidance, with 35% mentioning the implications but not formally including them. This compares to 45% of S&P 600 Consumer Discretionary companies in both buckets, respectively. Just three companies in the S&P 500 pulled guidance for the year, while that number was doubled for their small cap counterparts.

From our perspective, the choice not to embed tariffs into guidance carries greater risk, as these companies are now facing the dual headwinds of heightened expectations and the inherent risk in the assumption that the street would give hall passes to any tariff-induced misses. Similarly, those companies that pulled or did not release guidance effectively kitchen-sinked the year - which could lead to heightened scrutiny and caution from investors if these same companies post strong fundamental results in the coming quarters.

By contrast, it is our view that the choice to embed tariffs into guidance - to any degree - was the most prudent, as in many cases it re-set the bar of expectations for companies to a level that is now very attainable - particularly under a scenario where a broad swath of reciprocal tariffs are lowered or removed entirely. Guiding this conservatively effectively relieves a significant amount of pressure on both the back-to-school and holiday periods to achieve the full-year guide, at a time when there is little by way of consensus expectations for a strong or improving consumer. With decent jobs data, sticky housing prices, and inflation largely in check - the second half of the year has the makings of what could be a very strong close to the year for select swaths of Consumer Discretionary, regardless of how tariff negotiations progress (or stall) through the summer.

We remain bullish on the overall sector against these muted expectations, and specifically are buyers of companies with best-in-class management teams producing superior products and services with the vision and capacity to execute against strategic priorities despite the ongoing narrative volatility. With the start of the second quarter earnings season, we will be closely monitoring company statements for any signs of consumer stress.

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