Labor Market Volatility and Equity Valuations: Assessing Cyclical Sector Risks in 2025

The U.S. labor market in 2025 has entered a phase of cooling, marked by slower hiring, rising unemployment, and heightened business uncertainty. According to a report by JPMorgan, weekly jobless claims surged in late 2025, partly due to seasonal adjustments but signaling underlying fragility. Payroll growth averaged just 29,000 jobs per month from May to October 2025, a stark decline from earlier in the year. The unemployment rate climbed to 4.4% in September 2025, with projections of a peak at 4.5% in early 2026. These trends reflect a labor market grappling with trade policy uncertainty, reduced immigration, and the delayed impact of AI and automation on job creation as research shows. While wage growth remains above pre-pandemic levels, it has slowed in the second half of 2025. This backdrop raises critical questions about the implications for equity valuations, particularly for cyclical sectors sensitive to employment and consumer spending.

Cyclical Sectors Under Pressure: Industrials and Materials

The industrials and materials sectors, which rely heavily on labor supply and demand, are particularly vulnerable to labor market volatility. Data from Deloitte indicates that the Institute for Supply Management's manufacturing purchasing managers' index (PMI) remained below 50 for much of 2025, signaling contraction in the manufacturing industry. This contraction was accompanied by rising costs, declining employment, and reduced construction spending. Tariff policies and trade uncertainty have further exacerbated these challenges, pulling demand forward and creating uncertainty about long-term growth. For example, Morgan Stanley notes that tariffs have created a "wildcard" in the economic outlook, with potential inflationary effects complicating the operating environment for manufacturers.

Equity valuations in these sectors have been impacted by the combination of trade policy headwinds and labor market softening. Companies in industrials and materials are grappling with reduced demand for manufactured goods and higher input costs. While the Federal Reserve's rate cuts and fiscal policies have provided some support, the sector's earnings remain mixed. Investors must weigh the risk of further labor market deterioration against potential tailwinds from AI-driven productivity gains and fiscal stimulus as research shows.

Consumer Discretionary: A Sector at Risk

The consumer discretionary sector, which is highly sensitive to employment trends and consumer spending, has faced significant equity valuation risks in Q3 2025. S&P Global Market Intelligence reports that 41 companies in the sector received credit rating downgrades since the start of 2025, the highest number among all sectors. These downgrades reflect concerns about elevated credit risk and a weakening performance outlook. Clearstead notes that the labor market slowdown-evidenced by job growth declining from an average of 150,000 per month in early 2025 to under 30,000 per month by August-has raised alarms about long-term economic stability.

The sector's vulnerability is compounded by structural shifts in labor supply. Reduced immigration and aging demographics have tightened the labor market, with the labor force participation rate falling from 62.65% in July 2024 to 62.22% in July 2025. This contraction in labor supply has disproportionately affected lower-income households, which are critical drivers of consumer discretionary spending. As a result, private equity firms are reevaluating exits from portfolio companies in the sector, signaling a cautious outlook.

Broader Implications for Equity Valuations

The interplay between labor market volatility and equity valuations is further complicated by a K-shaped recovery, where high-net-worth investors and top-tier consumers benefit disproportionately. Vanguard projects 2.25% GDP growth in 2026, driven by AI investment and fiscal policy, but this optimism is not shared by all. CNBC highlights that while high-net-worth individuals reported an 11% improvement in sentiment in November 2025, broader consumer sentiment has declined. This divergence underscores the risk of a market correction if labor market weakness spills into small businesses and lower-income households as research shows.

For cyclical sectors, the risk of a modest correction in the second half of 2025 remains a key concern. JPMorgan notes that the labor market has "bent rather than broken," with unemployment rising to 4.4% but still below historical peaks. However, the sector-specific headwinds-such as trade uncertainty and rising costs-suggest that equity valuations may remain volatile. Investors are advised to adopt through-cycle strategies and disciplined capital allocation to navigate these challenges as research shows.

Conclusion

Labor market volatility in 2025 presents a complex landscape for equity valuations, particularly for cyclical sectors. The industrials and materials sectors face contractionary pressures from trade policies and labor shortages, while the consumer discretionary sector grapples with credit risks and shifting consumer behavior. Despite these challenges, the labor market's resilience-marked by low layoff rates and stabilization in some sectors-suggests a severe downturn is not imminent as research indicates. However, the uneven distribution of economic gains and the potential for further labor market deterioration highlight the need for vigilance. As the Federal Reserve and policymakers navigate this environment, investors must balance optimism about AI-driven growth with caution regarding sector-specific risks.