Divergent Momentum in U.S. Economy: Navigating Investment Opportunities in Services and Manufacturing Sectors

The U.S. economy in 2025 is a tale of two sectors. The latest S&P Global Composite PMI data reveals a stark divergence: the services sector is surging, while manufacturing struggles under the weight of tariffs, input costs, and policy uncertainty. For investors, this divergence presents both opportunities and risks, demanding a nuanced approach to capital allocation.

Services Sector: Resilience Amid Inflationary Pressures

The services sector has become the backbone of U.S. economic growth. In July 2025, the Composite PMI for services hit 54.6, the fastest pace since December 2024, driven by robust domestic demand. Businesses are expanding backlogs at the steepest rate in three years, and employment in the sector rose to its highest level since early 2022. Sub-sectors like healthcare, professional services, and technology are thriving, with firms passing on higher input costs to customers.

However, risks loom. The Prices Paid Index in services climbed to 69.9, reflecting inflationary pressures from tariffs and labor costs. While demand remains strong, business confidence has dipped, with firms citing federal spending cuts and trade policy volatility as key concerns. Investors should focus on sub-sectors with pricing power, such as cybersecurity and AI-driven services, which are less sensitive to macroeconomic swings.

Manufacturing Sector: A Fragile Recovery

The manufacturing sector, in contrast, is a patchwork of contraction and cautious optimism. The ISM Manufacturing PMI fell to 49.0 in March 2025, signaling a contraction, with new orders and production indices below 50. Tariffs on steel and aluminum have exacerbated input costs, while employment in manufacturing plateaued at 12.8 million. Sub-sectors like machinery and computer electronics are growing, but industries such as textiles and chemicals are shrinking.

Investors must tread carefully. Rising material costs—steel up 30%, copper 25%—are squeezing margins, and inventory imbalances (ISM's New Orders minus Inventories at -8.2) suggest overstocking risks. However, nearshoring trends and domestic rail traffic growth hint at long-term potential for firms adapting to supply chain shifts.

Strategic Implications for Investors

1. Overweight Services, But Hedge Inflation: Allocate to services sub-sectors with strong pricing power, such as healthcare IT or premium consumer services. Use short-term hedges against input cost spikes, particularly in labor-intensive industries.
2. Selective Manufacturing Bets: Focus on manufacturers with exposure to nearshoring (e.g., industrial automation, logistics tech) and those benefiting from infrastructure spending. Avoid sectors reliant on global supply chains, such as textiles.
3. Monitor Policy Risks: Federal spending cuts and tariff adjustments could disrupt both sectors. Diversify portfolios across geographies and industries to mitigate policy-driven volatility.

The U.S. economy's divergent momentum underscores the importance of sector-specific strategies. While the services sector offers resilience, manufacturing's path is fraught with headwinds. Investors who align their portfolios with these dynamics—and remain agile in the face of policy shifts—will be best positioned to navigate 2025's economic landscape.