U.S. ISM Non-Manufacturing Sector Divergence: Energy Equipment and Services as a Rotation Play

The U.S. services sector, a cornerstone of economic activity, has shown signs of divergence in 2025. While the ISM Non-Manufacturing PMI (Services PMI) remains above the 50% expansion threshold, its recent readings—such as the July 2025 reading of 50.1% and the September contraction to 50%—highlight a slowing pace of growth. Employment in the sector has contracted for four of the last five months, and price pressures remain stubbornly high, with the Prices Index hitting 69.9% in July, the highest since October 2022. These trends, coupled with tariff-related disruptions and seasonal headwinds, suggest a fragile expansion.

Amid this backdrop, the Energy Equipment and Services sector emerges as a compelling rotation opportunity. While the sector has faced its own challenges—driven by lower oil prices and oversupply concerns—structural demand drivers are beginning to align for a potential rebound.

The Services Sector's Weakness: A Catalyst for Energy Sector Rotation

The services sector's slowdown is not merely a statistical anomaly but a reflection of broader economic dynamics. The ISM's Business Activity Index fell to 52.6% in July 2025, down from 54.2% in June, while New Orders contracted to 50.3%. These declines, though modest, signal a moderation in demand that could ripple through capital-intensive industries. Meanwhile, employment in services has contracted for four consecutive months, with the Employment Index at 46.4% in July. This labor market weakness, combined with elevated inflation, has left businesses and consumers with less discretionary spending power—a trend that could further dampen services-sector growth.

For investors, this divergence between the services sector's nominal expansion and its underlying fragility creates an opening to rebalance portfolios toward sectors with stronger fundamentals. Energy Equipment and Services, though currently undervalued, is positioned to benefit from several tailwinds:

1. Structural Demand for Energy Infrastructure: The development of LNG projects, such as Cheniere's Corpus Christi Stage III and ExxonMobil's Golden Pass, is expected to drive long-term demand for equipment and services. These projects require extensive drilling, transportation, and processing infrastructure, all of which are core to the Energy Equipment and Services sector.
2. Data Center Power Demand: U.S. power demand has risen 2.3% year-over-year, with data center hubs in Virginia and Texas accounting for significant growth. This surge in electricity consumption will require expanded natural gas and renewable energy infrastructure, creating opportunities for energy service providers.
3. Policy Tailwinds: The Trump Administration's $625 billion coal industry support package, including $350 million for recommissioning coal plants, could stabilize demand for energy equipment. While coal's long-term viability is debated, the short-term policy shift may delay retirements of aging infrastructure, preserving near-term revenue streams.

Energy Equipment and Services: A Sector at a Tipping Point

Despite a 20% year-over-year earnings decline in Q3 2025, the Energy Equipment and Services sector is showing early signs of stabilization. For example, Source Energy Services Ltd., a key player in frac sand and logistics, reported a 30% drop in sand sales volumes in Q3 2025 but anticipates a rebound in Q4 2025 and 2026. The company's optimism is rooted in expected LNG-driven proppant demand and expanded domestic sand production at its Peace River facility.

The sector's earnings recovery is also supported by improving cost structures. As operators cut expenses to preserve margins, demand for efficient, high-quality equipment and services is likely to concentrate among industry leaders. For instance, companies with strong balance sheets and diversified offerings—such as those with exposure to both oilfield services and renewable energy infrastructure—could outperform peers.

Strategic Investment Considerations

For investors seeking to capitalize on this rotation, the following strategies merit consideration:

1. Focus on LNG and Data Center-Linked Firms: Prioritize companies with exposure to LNG export terminals and power infrastructure projects. These firms are less sensitive to near-term oil price volatility and more aligned with long-term structural demand.
2. Monitor Policy Developments: The Trump Administration's energy agenda, including coal support and LNG export incentives, could create near-term volatility. Investors should track regulatory updates and their impact on project timelines.
3. Value Plays in Undervalued Sub-Industries: The S&P 500 Energy Equipment & Services Index is trading at a discount to its historical average, offering entry points for long-term investors. Firms with strong cash flow visibility, such as those with long-term contracts for LNG projects, are particularly attractive.

Conclusion: Positioning for a Divergent Recovery

The U.S. services sector's divergence from broader economic fundamentals underscores the need for strategic sector rotation. While the services sector remains in expansion, its weakening labor market and inflationary pressures create a risk-averse environment. In contrast, the Energy Equipment and Services sector, though currently challenged, is poised to benefit from structural demand, policy tailwinds, and a rebound in capital spending.

Investors who act now—targeting firms with exposure to LNG, data center power, and policy-driven infrastructure—can position themselves to capitalize on a sector that is likely to outperform in the second half of 2026. As the services sector's growth moderates, energy equipment and services may emerge as the unexpected beneficiaries of a shifting economic landscape.