Diverging Fortunes: U.S. Manufacturing and Services Sectors in 2026 and the Case for Strategic Sector Rotation

The U.S. economy in 2026 is increasingly shaped by a K-shaped recovery, where the manufacturing and services sectors have diverged sharply in performance. This divergence has profound implications for investors, who must navigate a landscape where sector rotation and risk diversification are no longer optional but essential.

Manufacturing: A Sector in Retreat

The U.S. manufacturing sector has faced persistent headwinds, with the Institute for Supply Management (ISM) manufacturing purchasing managers' index remaining below 50 for much of 2025-a clear signal of contraction. Employment in the sector has declined, and manufacturing construction spending has fallen steadily, driven by trade policy uncertainty and tariffs. Despite the passage of the One Big Beautiful Bill Act, which introduced tax provisions aimed at lowering costs and encouraging investment, the sector remains fragile. As of August 2025, over 13 million people were employed in manufacturing, with 409,000 job openings, highlighting both labor shortages and weak demand.

The sector's contribution to GDP, while still significant at 9.4% in Q2 2025 ($2.90 trillion), masks deeper structural challenges. Tariffs and global supply chain shifts have eroded competitiveness, while reshoring efforts remain uneven. For investors, manufacturing's struggles underscore the risks of overreliance on cyclical industrial assets in a policy-driven environment.

Services: A Resilient Engine of Growth

In contrast, the services sector has shown remarkable resilience. Real GDP growth in the third quarter of 2025 surged by 4.3%, driven by consumer spending, exports, and government outlays. Within services, professional, scientific, and technical services are projected to grow by 10.5% from 2023 to 2033, with computer systems design and related services expected to expand by 19.5%- a reflection of rising demand for AI, cybersecurity, and IT outsourcing.

This growth is not merely cyclical but structural. The services sector's dominance in the U.S. economy-accounting for over 80% of GDP-makes it a critical buffer against manufacturing's struggles. However, even within services, risks persist. The labor market, while still strong, has slowed, with the unemployment rate rising to 4.3% in August 2025. Moreover, the sector's reliance on productivity gains and technological adoption means overconcentration in AI-driven themes could amplify volatility.

Sector Rotation and the Case for Diversification

The divergent trajectories of these sectors demand a nuanced approach to portfolio construction. As noted by S&P Global Market Intelligence, the U.S. economy's "K-shaped" dynamics-where growth is unevenly distributed-highlight the need for balanced exposure. Investors are increasingly rotating into cyclical sectors like energy and industrials, while also hedging against AI-driven earnings concentration.

Policy shifts further complicate the calculus. The One Big Beautiful Bill Act and revised trade deals with the UK and Vietnam offer long-term tailwinds for manufacturing, but near-term challenges persist. Meanwhile, services sector growth is supported by domestic demand and technological tailwinds, though inflationary pressures and regulatory scrutiny could temper gains.

For risk diversification, a strategic blend of manufacturing and services exposure is prudent. Private companies are already shifting capital toward domestic manufacturing and energy infrastructure, supported by policy incentives. Yet, services-particularly high-growth tech-driven subsectors-remain critical for capturing productivity-driven returns.

Conclusion: Balancing the Scales

The U.S. economy's diverging sector performances in 2026 present both opportunities and risks. Manufacturing's struggles reflect deep-seated structural challenges, while services' resilience underscores the power of innovation and consumer demand. For investors, the path forward lies in strategic sector rotation-leaning into services for growth while selectively positioning for manufacturing's long-term rebalancing. As always, diversification remains the cornerstone of managing a K-shaped economy.