Consumer discretionary: Fueled by spending

Despite pressures from interest rates and inflation, Americans continued to open their wallets in 2024 as the economy generally stayed resilient. This fueled market-beating gains for the consumer discretionary sector, which encompasses companies that sell primarily nonessential goods and services like new cars, home-improvement supplies, and hotel stays.

For 2025, these stocks are likely to continue to rise or fall with the fate of US consumers and the broader economy. If economic growth and the job market remain on track, consumers are likely to keep spending. Plus, further rate cuts from the Fed could help alleviate some of the recent pressures on consumers, freeing up cash or credit for some of the bigger-ticket home-improvement and auto-related purchases they've delayed in the recent high-interest-rate environment.

2024: Coming off a strong year

Solid US economic growth was a major headline for the sector in 2024, with resilient consumer spending at the heart of the story. Although some worries about rising unemployment cropped up through the year, the job market remained steady. At the same time, wages grew faster than inflation, allowing consumers to start clawing back some of the purchasing power they'd lost to inflation in recent years.

But under the surface was a tale of 2 consumers. Higher-income earners disproportionately drove overall spending—backed by gains in income, new record highs in the stock market, and rises in home equity. Lower-income earners, who have generally been squeezed harder by inflation and high borrowing costs, showed signs of pulling back on nonessential spending like restaurant meals, clothes, and entertainment.

This backdrop gave way to mixed performance among the sector's various industries. For example, home-improvement and auto-parts retailers struggled as consumers delayed housing renovation and improvement projects. On the other hand, the 2 largest constituents in the sector, Amazon () and Tesla (), both experienced strong gains as investors generally favored mega-cap tech-related stocks. And homebuilding stocks rallied on hopes that interest-rate cuts will eventually lead to lower mortgage rates and, in turn, stronger demand for new housing.

Yet as a sector, consumer discretionary delivered strong performance in 2024. Although the sector trailed the market for most of the year, by mid-December a year-end rally had put it on track to potentially best the S&P 500^®.

2025: Same economic trends, potentially new government policies

In 2025, I believe sector-level performance will likely continue to be driven by macroeconomic crosscurrents. Lower inflation and further rate cuts from the Fed could benefit the sector, as consumers might be more likely to purchase big-ticket items such as cars or houses. Better still would be if the economy continues to grow, continues to avert recession, and the labor markets remain strong. If the US were to enter a recession and consumers pull back their spending, consumer discretionary stocks could face pressure.

One consideration that may impact many sectors in 2025 could be any policy shifts from the incoming presidential administration and makeup of Congress. At a high level, proposed policies could have mixed impacts on the consumer discretionary sector. Lighter regulation, a lower corporate tax rate, and a tougher stance on retail theft could all provide potential tailwinds if executed upon. Higher tariffs would likely have a negative impact either on US consumers or the US firms that import goods, depending on whether these firms are able to pass these higher costs on in the form of higher prices for consumers.

Potential value in home and auto categories

With the evolving business cycle in mind, interest-rate-sensitive industries, such as auto- and home-related categories, look interesting. Not only have these groups recently sported attractive valuations, but they have tended to lead the market's advance amid the first signs of lower interest rates because they typically benefit from increased borrowing.

For instance, Lowe's () is the second-largest home-improvement retailer in the US. Although demand for big-ticket discretionary renovations has been soft, most of Lowe's business has been driven by less-discretionary maintenance activity. Plus, the company could be a potential beneficiary of key long-term trends. For one thing, the housing stock continues to grow and age, necessitating greater maintenance activity. Additionally, record home prices and home equity levels could be supportive for improvement and renovation spending. The lock-in effect of homeowners staying in place longer, including older homeowners aging in place, is apt to prompt renovation activity within existing residences. It is also worth mentioning that increasingly severe weather has been contributing to storm damage in the US housing stock, necessitating increased repair activity.

Aptiv ()² is a supplier of automotive components and software that has significant exposure to the electric vehicle (EV) market and that has historically traded at a hefty valuation relative to peers. But the stock has fallen over the past year on investor concerns about a slowdown in EV adoption. However, I believe much of this fear may be shortsighted, as I think investors have overlooked improvements in the company's cash-flow profile. Over the longer term, EV adoption is projected to eventually swell.³

A focus on stock selection

To be sure, as I look to 2025 there are reasons for near-term caution on the economic and consumer backdrop. While I believe it is important to be aware of the macro environment, my investment process is primarily based on bottom-up fundamental research and an evaluation of the prospects for individual stocks. Fortunately, consumer discretionary is a diverse sector that can offer pockets of attractive valuation in a variety of market environments. Fidelity's research insights can help me uncover those companies with strong risk-reward profiles and long-term growth potential.