The U.S. economy isn’t sprinting, but it’s still moving. The services sector just proved it.
KEY TAKEAWAYS
The ISM Services PMI rebounded to 52.4 in October, signaling modest expansion
Business activity and new orders improved, but employment remains in contraction
Prices index hit 70–showing sticky service inflation remains a problem
Shutdown and tariffs continue to weigh on sentiment and supply chains
Markets remain focused on earnings strength and the possibility of a soft landing
MY HOT TAKES
The services economy just gave the US another lease on life
Inflation isn’t dead–it’s just hiding in the services sector
The Fed is stuck watching sticky prices and weak hiring at the same time
Markets are climbing on thin air, but still climbing
The soft landing remains plausible–but not guaranteed
You can quote me: “Sticky service inflation is the Fed’s real nightmare—and it’s alive and well.”
Full service. We are now in uncharted territory as far as government shutdowns go. Markets are well-aware of the economic implications, though it is not as evident as one might expect. Why? Well, it is likely that–shocking though it may sound–there are bigger fish to fry for the markets these days. It is true that valuations are stretched a bit. We didn’t need the world's most powerful private bankers to remind us of that. The fact is, they did, and that seemed to worry the street more than some of the real challenges that equities will face in the months ahead.
Let’s not get into why or why-not these nosebleed valuations are justified. It is clear that some sectors are more stretched than others, and it is clear that at some point someone will be left holding the bag. For those of you that don’t know, “holding the bag” is Wall Street terminology for the person left without a chair when the music stops in musical chairs. The message here is that investors need to be really selective in toppy markets like these.
Taking a quick step back. S&P 500 year-over-year earnings growth has been pretty impressive so far in this current earnings season. With 425 S&P companies reporting so far, the aggregate overall growth has been 12.15%, far exceeding my ~8% estimate which was in line with the consensus. Tech, which is far from done, has logged an impressive 23.19% growth, while energy has displayed a year-over-year -0.05% decline in EPS. That can have something to do with why the S&P is hovering right below all-time highs.
Just by eyeballing this bar chart of the S&P 500, you can clearly see an index that is listing a bit. Kind of like an out-of-breath mountain climber just near the peak. The big question remains, can the climber pull it together and mount another surge to bring home the year at the top? This is, after all, a historically strong time of year for stocks. In fact, if you look back 20 years, you will note that November–THIS MONTH–is historically the strongest for the S&P 500, with an average return of 2.26%!
Stepping back just a little bit further, there are some other tailwinds that should help our intrepid climber back on his/her feet. Even though the Fed, or the Grey Bankers as I like to sometimes refer to them as, seems as dysfunctional as ever–playing their safe, but dangerous game with monetary policy, seem at least predisposed to easing financial conditions. Exactly which month and by how many quarters of a percentage point really doesn’t matter as much as many think. The fact is that the Fed is in a normalization cycle… for now.
Whether or not you were a fan of the One Big Beautiful Bill Act, it is clearly poised as fiscal stimulus and it will add to the prevailing economic tailwinds. Be patient, it's out there. 😉 We also have the wealth effect keeping consumption bumping and pumping. The S&P 500 is up by some 16% year to date and that makes consumers feel somehow richer–and more likely to grab that credit card and swipe.
This is the part of the discussion, where I would typically cite some great macro economic data to provide more color to help us better determine if our intrepid climber will hit the peak or fall back down the mountain, but alas, there is no economic data to mention–not from the government at least. So, we go back to the private numbers. ADP Jobs came in slightly better than expected, though still tepid–and that’s giving it the benefit of the doubt. The actual number exceeded estimates by 12,000 jobs. That’s good, but 12k jobs in the bigger picture can hardly be called a surge. Earlier this week, I wrote about the ISM Manufacturing survey which painted a pretty grim picture for the manufacturing sector which contributes ~10% of the economy. The remaining fuel comes from the services sector, so it is fair to say that its health is critical for our economic success.
Yesterday’s ISM report actually offered some much-needed oxygen for our weary climber. Economic activity in the services sector rebounded in October, with the index registering 52.4 compared to September’s barely-breathing 50. That’s two full points of improvement and marks the eighth time this year that services have expanded. It’s not a sprint, but it’s at least a step in the right direction. This uptick matters, because services represent roughly three-quarters of the U.S. economy. Manufacturing, which has been struggling in contraction for months, might get all the sympathy headlines, but services are what keep the heart beating. If the services side starts to firm up again, it can offset some of the weakness elsewhere, and that’s exactly what this latest reading suggests.
The details paint a picture that is cautiously positive. Business activity rebounded sharply to 54.3, the highest level in several months, while new orders surged to 56.2, the best since October of last year. That’s a clear sign that demand hasn’t gone into hibernation. Companies are still taking on work, customers are still signing contracts, and there’s still motion in the system. But not everything in this report glitters. Employment, which remains the soft spot in the services picture, contracted for the fifth straight month. The reading came in at 48.2, up a tick from September’s 47.2, but still below the 50 mark that separates growth from decline. Companies appear to be holding on to workers but are reluctant to add new ones. That restraint says a lot about how business leaders view the coming months. HINT: they’re hedging. 😉
It’s not all caution and cutbacks, though. The Prices Index, at 70.0, is proof that inflation is still alive and kicking. This is the highest reading since October 2022, and it’s been above 60 for 11 straight months. Respondents continue to cite tariffs as a key reason for higher input costs, particularly for anything that touches manufacturing or imported materials. Gasoline and diesel prices were down, but that relief was more than offset by rising costs in labor, electrical components, and various service contracts. This combination of rising prices, improving demand, and weak hiring, is a cocktail that tends to keep the Fed up at night. It’s what you might call “sticky service inflation,” and it’s precisely the kind of thing that keeps rate-cut dreams from becoming reality too quickly.
Backlogs, on the other hand, fell off a cliff, down 6.5 points to 40.8. That’s deep into contraction territory and the second-lowest reading since the financial crisis in 2009. Companies can clearly keep up with what’s coming in, and that’s both good and bad. It means supply chains are healthy, but it also means there’s not a ton of pent-up demand to draw on if orders start to wobble. Inventories remain a bit too high. An index reading of 49.5 suggests slight contraction, but the sentiment measure at 55.5 indicates that many businesses still feel they’re sitting on more stock than they’d like. In other words, they are still working through the hangover from earlier over-ordering and aren’t rushing to restock.
Industry-level details reveal the patchwork nature of this expansion. Eleven industries grew in October, including Accommodation and Food Services, Retail Trade, Real Estate, Health Care, and Utilities. These are essentially the parts of the economy tied to everyday living. On the other side of the ledger, six industries contracted, notably: Finance, Construction, and Public Administration. That last one (government-related services) was hit particularly hard by the ongoing shutdown, with one respondent saying that “non-essential functions” have been shuttered and furloughs are looming if the impasse continues. So, while the overall index is expanding, the composition shows that the strength is not evenly distributed. Consumer-facing and service-heavy businesses are holding their ground, while government and capital-intensive sectors are straining under uncertainty.
Several respondent comments highlight what’s really happening beneath the surface. “Activity is generally flat month-over-month; we are closely monitoring effects of the new tariff announcement,” said one from the Finance & Insurance sector. Another from Management of Companies warned, “The federal government shutdown has shuttered many non-essential functions. This will lead to project delays and likely hurt our overall fiscal year 2026 expectations.” 👀 The Real Estate sector described the economy as “providing mixed signals,” while Retail reported “business very strong, no supply chain or logistical issues.” You can almost hear the tug-of-war between confidence and concern, between steady footing and the loose gravel beneath it.
Supplier deliveries, interestingly, are no longer much of a problem. The index came in at 50.8, signaling slightly slower deliveries, which the ISM interprets as normal when the economy improves. Respondents mentioned stable delivery timelines and relatively smooth logistics, though there were still complaints about tight availability for high-performance components and semiconductors–likely remnants of the post-pandemic supply jams that never fully recovered. Imports, however, were sharply lower at 43.7, reflecting either a real slowdown in global trade or the conscious decision by firms to source closer to home in response to tariffs. Several respondents explicitly mentioned shifting procurement to US, Canadian, or Mexican suppliers. That’s consistent with the administration’s push for reshoring, but it also implies potential cost friction in the months ahead as companies adjust to new supply patterns.
What does all of this mean for growth? ISM Chair Steve Miller suggested that a Services PMI of 52.4 historically maps to about 1.2% annualized real GDP growth from services, which is modest, but hey, still growth. It reinforces the idea that while the US economy may be losing altitude, it’s not yet stalling. The private sector, particularly services, is still doing just enough to keep the plane in the air while the fiscal side fights over the control tower. The divergence between services (expanding) and manufacturing (still contracting at 48.7) is now familiar. Manufacturing tends to lead in downturns and recoveries, while services lag, but this cycle is more complicated because of tariffs, labor costs, and the stop-start nature of fiscal policy.
So where does that leave us? The U.S. economy is not in freefall, but it is clearly operating with one eye on the weather. Rising prices, mixed employment, and the continuing effects of the shutdown are real headwinds. But the resilience in new orders and the rebound in business activity suggest that the underlying demand engine hasn’t quite seized up. Consumers are still spending, companies are still delivering, and the services economy–the one that ultimately matters–is still breathing. That’s more than can be said for some other major economies at the moment.
As for markets, this report probably does little to change the narrative. It won’t push the Fed into cutting early, nor will it prompt an immediate rally. But it does validate the idea that the soft landing remains… well, plausible. If services can stay above 50, inflation cools even marginally, and the Fed keeps a steady hand, the economy could avoid slipping off the ridge. It’s a delicate balance, and it assumes the shutdown doesn’t last much longer or start bleeding into consumer confidence. Unfortunately, every day it continues raises the risk that uncertainty migrates from Washington’s chambers into corporate hiring plans and household spending.
Still, our climber isn’t done yet. After days of slipping and gasping for air, there’s finally a bit of footing. The services economy. Think of it as the climber’s oxygen mask is back on and delivering enough flow to possibly keep moving higher. But the summit is not a guarantee. Inflation remains an altitude sickness that could strike again if prices stay this high. Labor market fatigue could also creep in, particularly if the Fed remains tight for too long. The path up the mountain is never a straight line, and every hiker knows that even near the peak, the winds can change fast.
The good news is that we’re still climbing. The footing may be loose, the air may be thin, but the view is getting clearer. If fiscal winds shift in our favor, if the Fed steadies its pace, and if services can continue to carry their share of the load, we may yet reach the top before the year’s end. Just keep your eyes on the rope and your weight balanced, because this climb isn’t over, and gravity, as always, never quits. 🧗
YESTERDAY’S MARKETS
Stocks gained yesterday as the Supreme Court’s questioning gave hope that tariffs may not be legal. Don’t get too excited–it ‘aint over ‘till it’s over. 10-year Treasury Note yields marched higher, because no tariffs imply larger deficit–it’s crazy, but factual.
NEXT UP
No official government data today…again, BUT listen to what these FOMC members have to say: Williams, Barr, Hammock, Waller, Goolsbee, Paulson, and Musalem. That’s a lot of hot air, but those folks are the ones that control rates, so maybe, it’s best to pay attention.
Important earnings today: Air Products and Chemicals, DuPont de Nemours, Planet Fitness, Tapestry Brands, Hyatt Hotels, Papa John’s, D-Wave, TripAdvisor, Core Natural Resources, Moderna, Datadog, Rockwell Automation, Warner Bros Discovery, Cummins, Parker-Hannifin, Ralph Lauren, Microchip Technology, Affirm Holdings, Monster Beverage, DraftKings, Peloton, Expedia, Sweetgreen, Airbnb, Block, NuScale Power, and Soundhound.