U.S. ISM Non-Manufacturing PMI Signals Sector Rotation Opportunities in a Resilient Services-Driven Economy

The U.S. ISM Non-Manufacturing PMI (NMI) has long served as a barometer for the health of the services sector, which accounts for roughly 70% of GDP. The latest August 2025 reading of 52.0—a 1.9-point increase from July—underscores the sector's resilience amid persistent inflationary pressures and labor market challenges. This expansion, now in its 63rd consecutive month, offers a roadmap for investors seeking to align portfolios with the evolving dynamics of a services-driven economy.

The Data-Driven Case for Sector Rotation

The NMI's components—Business Activity, New Orders, Employment, and Supplier Deliveries—paint a nuanced picture. While Business Activity (55.0) and New Orders (56.0) surged, Employment (46.5) and Supplier Deliveries (50.3) signaled ongoing fragility. This divergence suggests a sector expanding on demand but constrained by labor shortages and supply chain bottlenecks.

Historically, such conditions have favored sectors with inelastic demand and pricing power. For instance, when the NMI exceeds 52.0, as it did in July and August 2025, industries like industrials, consumer discretionary, and logistics have outperformed. Companies such as Delta Air Lines (DAL) and United Parcel Service (UPS) have historically capitalized on rising business travel and e-commerce activity.

Conversely, sectors like healthcare and utilities—which rely on stable margins—have underperformed during high-PMI periods. UnitedHealth Group (UNH), for example, has lagged the S&P 500 by 8% year-to-date, reflecting margin compression from rising input costs and regulatory pressures.

Navigating Inflationary Pressures and Tariff Impacts

The Prices Index (69.2) remains near a three-year high, with 16 of 18 services industries reporting cost increases. This inflationary backdrop favors companies with pricing power, particularly in professional services, real estate, and education—industries that expanded in August. Conversely, sectors like accommodation and food services face headwinds from tariffs on imported goods, which have squeezed margins and dampened demand.

Investors should also monitor the Backlog of Orders Index, which hit a 16-year low at 40.4. This suggests that while demand is robust, capacity constraints are easing, potentially reducing upward pressure on prices. Sectors like construction and finance—which reported contractions in August—may see a rebound if backlogs normalize.

Strategic Positioning for a Services-Driven Economy

Given the NMI's role as a leading indicator, tactical allocations should prioritize:
1. Industrials and Consumer Discretionary: These sectors benefit from rising business activity and corporate spending.
2. Logistics and Transportation: UPS and FedEx (FDX) are well-positioned to capitalize on e-commerce growth and supply chain efficiency.
3. Defensive Tech and Real Assets: Inflation-linked assets (e.g., REITs) and SaaS platforms (e.g., Snowflake, Palantir) offer stability amid volatility.

Conversely, underweight healthcare and utilities, which face margin compression and regulatory risks. A small allocation to defensive sectors (e.g., healthcare, utilities) can act as a buffer if the September 2025 PMI (currently at 50.3) signals a slowdown.

Conclusion

The U.S. services sector remains a cornerstone of economic resilience, but its expansion is not without challenges. By leveraging the NMI's insights, investors can identify sectors poised to thrive in a high-PMI environment while hedging against inflationary and labor market risks. As the economy navigates tariffs and cost pressures, data-driven sector rotation will be key to unlocking long-term value in a services-driven world.

****