Shifting Gears: Why Investors Should Rotate from Cyclical Chemicals to Tech Services Amid Weakening Industrial Demand

The U.S. manufacturing landscape in 2025 is marked by stark divergences. While core durable goods orders (excluding transportation) have shown resilience, the broader industrial sector remains under pressure. The June 2025 data revealed a 9.3% monthly decline in new orders for manufactured durable goods, driven largely by the transportation equipment segment—a drop of 22.4%—reflecting the fallout from aggressive tariff policies and supply chain bottlenecks. Yet, core durable goods (excluding transportation) edged up 0.2%, with year-over-year growth of 2.2%, underscoring the relative stability of machinery, industrial equipment, and defense-related manufacturing.

This fractured environment highlights a critical investment opportunity: rotating capital from cyclical chemical industries, which face uneven demand and regulatory headwinds, to tech services, which are capitalizing on digital transformation and AI-driven innovation.

The Case for Sector Rotation: Cyclical Chemicals vs. Resilient Tech Services

The chemical industry, while posting modest global growth of 3.5% in 2025, is grappling with structural challenges. U.S. industrial production growth has lagged, rising by just 0.2% in 2023 and remaining flat in 2024. Companies in this sector are increasingly focused on cost efficiency and sustainability, with investments skewed toward semiconductors and clean energy. However, these efforts are constrained by supply chain volatility and geopolitical risks, particularly in regions like Europe and Asia.

In contrast, the tech services sector is thriving. Digital transformation, cloud computing, and AI adoption are driving demand for scalable solutions. The S&P 500 Information Technology sector is projected to grow earnings by 16.9% in 2025, with cloud providers like Microsoft (Azure up 33% year-over-year) and Amazon Web Services (AWS up 17%) leading the charge. AI infrastructure spending alone surged 53% at Microsoft in its fiscal third quarter, reflecting a broader industry push to secure long-term competitive advantages.

A backtest of a sector rotation strategy from 2020 to 2025—shifting from cyclical chemicals to tech services during periods of industrial demand weakness—reveals compelling insights. While specific annualized returns and Sharpe ratios are not disclosed in available data, academic studies indicate that high-growth tech sectors outperform capital-intensive industries during economic expansions. The tech services sector's ability to scale digital solutions and benefit from a weaker U.S. dollar (which boosted earnings for global players like Apple and Alphabet) further strengthens its case.

Navigating Policy Risks and Macroeconomic Uncertainty

Investors must remain cautious of policy-driven headwinds. The Trump administration's tariff regime has disrupted supply chains, with Section 301 tariffs reducing semiconductor imports by 70% and domestic production rising only 1.2%. These distortions are particularly acute in infrastructure-linked industries, including chemicals and transportation. Meanwhile, looming tariffs on Japan, South Korea, Canada, and the EU by August 1 could exacerbate volatility.

However, tech services firms are better positioned to weather these shocks. Their reliance on intangible assets and global demand for digital infrastructure provides insulation from material price swings. For example, Microsoft's $16.75 billion AI infrastructure investment in Q3 2025 highlights the sector's resilience, even as industrial demand falters.

Actionable Insights for Investors

1. Overweight Tech Services Exposure: ETFs like XLK (Technology Select Sector SPDR) and individual stocks in cloud computing (e.g., Microsoft, Amazon) and AI infrastructure (e.g., Nvidia) offer concentrated exposure to high-growth sub-sectors.
2. Underweight Cyclical Chemicals: While chemicals may benefit from clean energy tailwinds, their earnings are more susceptible to commodity price swings and regulatory shifts. Consider reducing exposure to pure-play chemical producers in favor of diversified tech holdings.
3. Monitor Tariff Developments: Closely track policy announcements in August 2025, as new tariffs could trigger short-term volatility in both sectors.

Conclusion: Balancing Growth and Risk

The divergence between cyclical chemicals and tech services underscores a broader theme: in an era of industrial demand weakness and policy uncertainty, sectors with scalable digital offerings and global demand are better positioned to thrive. While chemicals will remain essential for high-growth areas like semiconductors and clean energy, their cyclical nature and exposure to supply chain risks make them less attractive in the near term.

For investors seeking to navigate macroeconomic headwinds, a strategic rotation toward tech services—backed by strong earnings growth, innovation cycles, and macroeconomic tailwinds—offers a compelling path forward. As the U.S. economy continues to grapple with fractured industrial dynamics, agility in sector allocation will be key to capturing long-term value.