5 Sector ETFs to Avoid for H2 2025

Considering the potential for new tariffs to begin impacting consumer goods prices in the coming months, combined with the prospect of a slowing economy (despite the passage of a new tax bill), investors may want to re-evaluate their exposure to certain sector ETFs through the end of 2025.  

The immediately forthcoming macroeconomic headwinds can disproportionately affect industries sensitive to consumer spending, international trade and economic growth.

With that backdrop in mind, we highlight five sectors and their respective top ETFs to potentially avoid or underweight in the coming months, based on their typical sensitivity to tariffs and economic slowdowns.

5 Sector ETFs that May Underperform in the Second Half

While the potential for trade deals and the stimulus from the passage of President Donald Trump’s “Big Beautiful Bill” can produce support for equities in the second half of 2025, inflationary forces and a slowdown in spending from consumers not directly benefitting from the tax relief place a question mark on the near-term outlook.

Here are the largest ETFs in each sector facing headwinds in 2025.

XLY: Inflation Squeezes Consumers

The consumer discretionary sector, led by the Consumer Discretionary Select Sector SPDR Fund (XLY), comprises companies that sell non-essential goods and services, such as automobiles, apparel, entertainment and luxury items.  

When tariffs increase the cost of imported components or finished goods, and consumer purchasing power is squeezed by higher prices and a slowing economy (impacting job growth and confidence), discretionary spending is often the first to be cut.  

XLI: Industrials Are Sensitive to Global Trade

Top holdings in the Industrial Select Sector SPDR Fund (XLI) includes companies involved in manufacturing, aerospace, defense, construction and transportation. These businesses are highly sensitive to global trade and economic activity. Tariffs on key inputs like steel, aluminum and other raw materials can significantly raise their production costs.  

A slowing economy also means reduced demand for new equipment, infrastructure projects and transportation services, directly impacting their revenue and profitability.

XLB: Tariffs Are a Drag on Raw Materials

Led by the Materials Select Sector SPDR Fund (XLB), these sector funds consist of companies that produce raw materials such as chemicals, metals, mining products (like copper) and construction materials. These industries are at the base of many supply chains and are highly cyclical. 

Tariffs can directly impact the cost of cross-border material flows, and a slowing global economy, especially if it affects major industrial consumers like China, can reduce demand for these fundamental inputs, leading to lower commodity prices and reduced earnings for materials companies.

XLK: Global Supply Chain Weighs on Tech

While parts of technology (like software) can be resilient, the sector, particularly hardware manufacturers and companies with complex global supply chains, is highly exposed to tariff impacts, which would place downward pressure on tech sector ETFs like the Technology Select Sector SPDR Fund (XLK). Many tech products rely on components sourced internationally, and tariffs can increase production costs, leading to higher consumer prices or squeezed margins. 

VNQ: Inflation, Slowing Economy May Ding Real Estate

If the newly passed tax law contributes to broader inflation and higher interest rates (due to increased national debt), it could make borrowing costs for mortgages and new developments more expensive, weighing on sector funds like the Vanguard Real Estate ETF (VNQ). 

Furthermore, if the economic slowdown impacts job growth and consumer confidence, the broader housing market could suffer, especially segments not directly benefiting from the high-end tax breaks. The bill's stated aim to reduce investments in energy-efficient homes could also be a minor negative for certain real estate development trends.

Related: Market Outlook: Best ETFs for the Second Half of 2025

Final Thoughts on ETFs to Avoid or Underweight Now

While the new tax bill may stimulate parts of the economy, its potential inflationary effects and the existing concerns around tariffs and a slowing economy likely reinforce the caution needed for these five sectors.

While Trump’s tax stimulus may provide some relief for higher-income households, the overriding impact of tariffs on global supply chains and a slowing global economy remain major threats. Furthermore, a tax-cut-related increase in consumer spending without a commensurate increase in supply can also add to inflationary pressures across the board.

With many potential outcomes leading to more cons than pros in 2025’s second half, investors should remain vigilant about how the above macro forces play out on a sector-by-sector basis.

Disclaimer: This article is for informational purposes only and does not constitute financial advice. Investing in ETFs involves risks, and investors should carefully consider their investment objectives and risk tolerance before making any investment decisions.

At the time of publication, Kent Thune did not hold a position in any of the aforementioned securities.