Services Sector Surpasses Expectations — As Manufacturing Falters

The U.S. ISM Non-Manufacturing PMI for December 2025, released at 54.4%, has shattered expectations and underscored a pivotal shift in the economic landscape. This 1.8-percentage-point jump from November's 52.6% reading marks the 10th consecutive month of expansion in the services sector—the highest level of the year—and signals a broad-based acceleration in economic activity. With all four key subindices—Business Activity, New Orders, Employment, and Supplier Deliveries—in expansion territory for the first time since February 2025, the data paints a picture of a services-driven economy gaining momentum. For investors, this is not just a statistical anomaly but a call to action: the time to recalibrate portfolios for a sector rotation toward infrastructure and construction-linked equities is now.

The PMI Surprise: A Services Sector on Steroids

The December reading of 54.4% implies an estimated 1.9-percentage-point annualized increase in real GDP, a stark contrast to the manufacturing sector's struggles. The Business Activity Index surged to 56%, while New Orders hit 57.9%, the highest since September 2024. Employment, which had contracted for seven months, returned to expansion at 52%, signaling a labor market finally catching up to demand. These numbers are not just about growth—they reflect a structural shift in how the U.S. economy is rebalancing.

The services sector is now operating at 90.2% of normal capacity, up from 86.5% in May 2025, with 11 industries—including Retail Trade, Finance & Insurance, and Accommodation & Food Services—reporting growth. Tariff-related supply chain adjustments, seasonal holiday demand, and end-of-year spending have amplified this momentum. Meanwhile, the manufacturing sector, operating at 82.4% of normal capacity, remains fragile, with weak exports and input cost pressures dragging on its performance.

Sector Rotation: From Defensive to Growth

The PMI data highlights a critical divergence between growth and defensive sectors. Historically, when the Services PMI exceeds expectations, trade-related industries such as industrials, consumer discretionary, and transportation outperform the S&P 500 by an average of 3-5 percentage points. This is because strong business activity and new orders directly fuel demand for logistics, infrastructure, and professional services.

Consider the case of United Parcel Service (UPS) and Caterpillar (CAT). UPS, a bellwether for supply chain efficiency, has seen its stock price surge in tandem with the PMI's upward trajectory, reflecting increased demand for last-mile delivery services. Caterpillar, a key player in construction and infrastructure, has similarly benefited from pent-up demand for heavy machinery as the services sector invests in capacity expansion.

Conversely, defensive sectors like healthcare and utilities, which typically thrive during economic slowdowns, have underperformed. UnitedHealth Group (UNH), for instance, has lagged despite stable demand, as margin compression from inflation and regulatory pressures erode earnings. This underperformance is not a temporary blip but a symptom of a broader trend: in a high-growth environment, capital flows toward sectors that scale with economic activity.

Actionable Strategies for 2026

The December PMI reading provides a roadmap for investors seeking to capitalize on the services sector's momentum. Here's how to position portfolios for the year ahead:

1. Overweight Infrastructure and Construction-Linked Equities
   The services sector's expansion is being driven by infrastructure investment, particularly in transportation, utilities, and real estate. Firms like Prologis (PLD), a leader in industrial real estate, and Digital Realty (DLR), which provides data center infrastructure, are poised to benefit from the surge in e-commerce and digital services. Additionally, construction equipment manufacturers like Deere (DE) and Komatsu (KMT) are likely to see increased demand as the sector rebuilds capacity.

2. Underweight Healthcare and Other Defensive Sectors
   While healthcare remains a critical part of the economy, its relative underperformance in a growth environment cannot be ignored. Investors should reduce exposure to healthcare services and instead allocate capital to sectors with higher growth potential. For example, the Professional, Scientific & Technical Services industry, which reported expansion in December, offers a more dynamic alternative.

3. Leverage the Fed's Rate-Cutting Cycle
   The Federal Reserve's anticipated rate cuts in 2026 will further amplify the appeal of rate-sensitive sectors like REITs and utilities. These sectors, which have historically outperformed during easing cycles, offer both yield and growth potential. However, investors should remain cautious about overexposure to sectors with high debt loads, as lower rates may mask underlying leverage risks.

4. Hedge Against Inflation with Inflation-Linked Assets
   Despite the PMI's positive signals, inflation remains a headwind. The Prices Index, at 64.3%, has stayed above 60% for 13 consecutive months. To mitigate this risk, investors should consider Treasury Inflation-Protected Securities (TIPS) and commodities like gold. Equities with strong pricing power, such as Coca-Cola (KO) and Johnson & Johnson (JNJ), also serve as effective hedges.

The Road Ahead: Balancing Growth and Stability

The December PMI reading is a clear signal that the U.S. economy is entering a new phase—one where the services sector, rather than manufacturing, will drive growth. However, this does not mean investors should abandon caution. The employment component, while improving, still lags behind historical averages, and inflationary pressures persist.

For now, the data supports a strategic shift toward sectors that benefit from the services sector's expansion. But as the Fed's policy trajectory and global trade dynamics evolve, flexibility will be key. Investors must remain vigilant, using the PMI as a compass to navigate the interplay between growth and stability in a world where economic momentum is no longer a question of if, but how much.

In the end, the December 2025 ISM Non-Manufacturing PMI is more than a number—it's a harbinger of change. Those who act swiftly to reallocate capital toward infrastructure and construction-linked equities, while tempering exposure to defensive sectors, will be best positioned to capitalize on the services-driven recovery. The question is not whether the economy is expanding, but whether your portfolio is ready for it.