Investment Strategy

Should investors be spooked by this labor market?

Softening job growth recently has moved to center stage in the Fed’s policy deliberations despite above-average economic growth and sticky inflation. Nonfarm payroll gains disappointed through the summer, with three-month average employment growth of just 29,000 through August — the weakest since the coronavirus-related slump in 2020.

To add insult to injury, preliminary benchmark revisions covering the 12-month period through March 2025 suggested 911,000 fewer jobs were created than previously estimated — and now a government shutdown has delayed the release of the widely anticipated September nonfarm payrolls report. So, just how spooked should investors be?

What lies beneath this labor market?

There are undoubtedly cracks forming in the labor-market picture. Recent college graduates have had more difficulty finding a job, and those looking for work have taken longer to find it. Another yellow flag for the economy is that weakening job growth has been led by declines in economically sensitive employment, cushioned by moderating gains in less economically sensitive health care, education, and government positions.

However, the overall unemployment rate remains historically subdued at 4.3%, as of August. Tighter immigration controls combined with increased retirees in an aging workforce have restrained labor supply. Tight supply has lowered the so-called “breakeven rate” — or the number of monthly job gains needed each month to maintain a stable unemployment rate — to roughly 40,000 a month, from approximately 100,000 last year.¹

In our view, much of the apparent weakness in the labor market stems more from a reluctance by businesses to hire than a willingness to fire workers in the current economic environment. That reluctance to fire has been apparent from the lack of a sustained rise in weekly initial unemployment insurance claims. We see the following forces contributing to a near hiring-firing freeze:

1. The stop-and-go nature of this year’s U.S. tariff increases — along with questions about the ultimate size, scope, and passthrough to the consumer — all have contributed to elevated policy uncertainties, which have stalled hiring. This uncertainty only recently has been counteracted by more generous corporate tax-cut provisions in the One Big Beautiful Bill Act.
2. Stricter immigration controls have constrained hiring in certain industries that rely more heavily on foreign-born workers, such as agriculture, construction, food services, hospitality, and in-home health care.
3. The focus on labor-saving AI development is just beginning to encourage a leaner, more productive workforce, allowing businesses to do more with fewer workers, which contributes to resilient economic growth.
4. To some extent, tepid job creation can be attributed to an unwind of the aggressive hiring spree tied to labor-shortage concerns after the pandemic. As Chart 1 illustrates, the gap between hiring and layoffs, unusually wide in the wake of the pandemic, is only now dipping below its narrower pre-pandemic norm.

Chart 1. Hiring versus layoffs gap narrowing but not as scary as it may appearSources: Bureau of Labor Statistics and Wells Fargo Investment Institute. Data as of September 30, 2025.

What it may mean for investors

Resilient economic growth despite slower job creation has discouraged broad-based layoffs accompanying businesses’ reluctance to hire. Still, we believe the Fed has become more sensitive to weakening job growth, prompting a dovish turn by policymakers despite lingering uncertainty around tariffs and the inflation outlook. We do not think a delay in government data tied to the government shutdown will necessarily preclude an interest-rate cut at the October 29 Fed meeting because private employment reports can serve as backup data to light the path. The likelihood of more aggressive interest-rate cuts in the coming months is one reason why we recently boosted our U.S. growth targets for 2025 and 2026.²

We believe lower short-term borrowing costs will combine with other key economic tailwinds (like tax cuts and deregulation) in fueling strong U.S. growth next year. Further, productivity gains have helped restrain unit labor costs supporting profit margins and earnings growth, especially benefiting our favored large-cap stocks and two of our favored equity sectors: Information Technology and Financials.

The bottom line: Investors can be excused for feeling uneasy during the month of October, a notoriously choppy period historically for stocks and other financial assets. We view the noise of government shutdowns and apparent confusion around economic-data delays only as temporary “hall-of-mirror” distractions. These headlines may incite Fed policy jitters and spark market volatility for a short time.³ However, we remain focused on more durable investment trends that we believe are laying the groundwork for a positive market environment through 2026.⁴

¹ Mike Reid and Carrie Freestone, “U.S. breakeven employment is falling,” Royal Bank of Canada, September 26, 2025.

² For further details, see Wells Fargo Investment Institute’s “Institute Alert: Adjusting targets and equity sector guidance,” September 16, 2025.

³ For more information, see Wells Fargo Investment Institute’s “Institute Alert: Bracing for a potential government shutdown,” September 29, 2025.

⁴ For more on this focus, see Darrell Cronk’s State of the Markets report: “Four signals above the noise,” September 23, 2025.

Financials show strength heading into year-end

Financials remain one of the most attractively positioned sectors as we approach year-end, in our view. Despite headlines around specific credit exposures, only moderate near-term earnings growth in core lending operations, and regulatory overhauls still in flight, we see the broader picture as one of resilience and opportunity.

Banks are entering this environment with strong balance sheets, diversified lending portfolios, and fee-based businesses that provide ballast against changing interest-rate dynamics. Payments and fintech firms continue to lead long-term digitization and embedded finance trends, supporting structural growth. Insurers benefit from disciplined underwriting and elevated reinvestment yields, while asset managers are capturing flows into income strategies and alternatives.

Valuation is a key advantage. Financials have been trading at a discount to the S&P 500 index while offering cyclical leverage — through lending, asset flows, and capital markets — and secular growth through innovation in payments and insurance. The chart highlights this relative valuation, reinforcing the sector’s attractive positioning.

The steepening of the yield curve adds an incremental tailwind: banks benefit from wider spreads on new lending, insurers can reinvest at higher rates, and asset managers stand to capture renewed flows into fixed income, potentially narrowing the valuation gap.

From an equities perspective, we believe this diversity of opportunities and risk profiles reinforces our constructive view. Our Global Securities Research sub-sector ratings reflect this balance — favoring banks for their diversified revenue streams and strong capital, while recognizing upside in asset managers and fintech tied to market and innovation cycles. In our view, financials have the potential to offer not just resilience but also target opportunities for alpha (excess return) generation.

Financial sector forward P/E relative to the S&P 500 Index forward P/ESources: FactSet and Wells Fargo Investment Institute. Data as of September 29, 2025. P/E = price to earnings. An index is unmanaged and not available for direct investment. Past performance is no guarantee of future results.  

Tech bonds do not reward investors for heavy AI spending

Corporate bonds issued by Information Technology companies have long traded at a premium to other investment-grade sectors. Business models that produced highly recurring revenue across diverse customer bases often drove balance sheet leverage to massive net cash positions and gave investors confidence that future business results would support debt repayment. Even in years of elevated investment, issuers still generated substantial free cash flow (amount of cash left over after expenses) after capital spending. Exceptionally tight credit spreads with limited upside were justified due to low risk.

The rush to build debt-funded cloud infrastructure to power AI software development is weakening the credit profile of many participating issuers in three ways:

1. Debt levels are rising well past previous levels, leaving highly rated companies with greatly reduced net cash positions and some triple-B rated issuers with debt levels above rating agency downgrade triggers.
2. Counterparty risk is rising with exposure to a concentrated costumer base of AI software developers, which have much more uncertain business prospects than existing corporate customers.
3. Heavy capital spending is expected to pressure free cash flow for the intermediate future and risks becoming the new normal as further technological advances could require greater investment.

Heavy debt-funded capital spending may ultimately pay off for these issuers; however, bond investors generally do not benefit when credit spreads are often much tighter than already tight-tech sector peers. Until spreads have moved wider and there is greater visibility on free cash flow prospects from AI development, we view these bonds as unattractive relative to others within U.S. Taxable Investment Grade Fixed Income.

Information Technology bond spreads show limited upside potential compared to other sectorsSources: Bloomberg and Wells Fargo Investment Institute, as of September 29, 2025; investment grade (IG) Index and sectors represented by the Bloomberg U.S. Corporate Index and its underlying sectors. An index is unmanaged and not available for direct investment. Past performance is no guarantee of future results.  

Limited Energy sector exposure to AI capital expenditure theme

The buildout of data center capacity continues to be the dominant theme in equity markets, and the future energy needs of these increasingly large data center projects have captured a lot of investor attention. With energy demand growing in both magnitude and visibility, why has the Energy sector underperformed the broader market year-to-date?

The answer lies within the composition of the Energy sector. Oil prices are the single most important driver of earnings for the sector, and oil is not used in large-scale domestic power generation. In contrast, we expect natural gas demand to increase substantially over the next several years, but natural gas prices are a smaller driver of earnings for the sector. We believe that natural gas prices may become more volatile, with periods of higher prices, but we are not predicting a sustained benefit to natural gas producers, as we believe there is ultimately enough latent production capacity to meet future demand.

Midstream Energy is one area of the Energy sector that we expect to be a long-term beneficiary of growing power demand, as the opportunity set for natural gas infrastructure continues to expand. However, this is a relatively small portion of the sector at just 12.8% (see chart).

Our neutral view of the overall Energy sector is driven by our expectation for oil prices to remain largely range-bound throughout 2026. We believe that the Utilities and Industrials sectors offer relatively more attractive exposure to AI-related power demand at the sector level. For more information and actionable ideas, please see our recent Sector Insights report, “Powering the AI Boom.”⁵

S&P 500 Energy sector composition by sub-industrySources: FactSet and Wells Fargo Investment Institute. Data as of September 29, 2025.

⁵ Wells Fargo Investment Institute Sector Insights Report, “Powering the artificial intelligence boom,” August 13, 2025.

Navigating change with Growth Equity

Growth Equity is a Private Equity sub-strategy that invests in established companies the strategy believes has potential to expand. The sub-strategy typically involves acquiring a minority stake in a company and partnering with that company’s management in-an-effort to accelerate growth. Expansion strategies for a company may include scaling operations, entering new markets, launching new products or technologies, or pursuing strategic acquisitions.⁶

Growth Equity strategies often seek companies that have generated cash flow, or the strategies anticipate a path to profitability.⁶ These companies tend to have favorable balance sheets and low use of debt⁶ which we believe may make them resilient in uncertain economic environments. Given Growth Equity sub-strategies’ focus on growth in a company, we expect the sub-strategy to frequently consider industries such as software, business service, financials, and health care⁶—sectors where growth and innovation often go hand in hand.

As of June 30, 2025, Growth Equity deal (investment) activity remained robust, averaging about 400 U.S. transactions per quarter since 2021 (see chart below). Over the past seven quarters, Growth Equity has consistently accounted for more than 20% of all Private Equity deals.⁶ According to Pitchbook,⁷ Growth Equity global assets under management surpassed $1.2 trillion in 2024.

In today’s evolving macroeconomic landscape, we believe Private Equity – Growth Equity sub-strategies may offer qualified investors a blend of diversification and long-term appreciation potential. It is important to point out that given the focus on growth, the future path of economic growth, government policy and exit environment can significantly impact the performance of Growth Equity. We remain favorable on Growth Equity sub-strategy, as it has continued to align with our growth and innovation themes.

Growth Equity deal count has increased since 2021Sources: Pitchbook and Wells Fargo Investment Institute. Data as of June 30, 2025. Q1 = first quarter. Q3 = third quarter.

Alternative investments, such as hedge funds, private equity, private debt and private real estate funds are not appropriate for all investors and are only open to “accredited” or “qualified” investors within the meaning of U.S. securities laws.

⁶ iCapital, “An introduction to Growth Equity”, July 6, 2023.

⁷ Pitchbook, “Private Capital Indexes Q1 2025”, August 4, 2025.

Cash Alternatives and Fixed Income

Equities

Real Assets

Alternative Investments**

Source: Wells Fargo Investment Institute, October 6, 2025.

*Tactical horizon is 6-18 months

**Alternative investments are not appropriate for all investors. They are speculative and involve a high degree of risk that is appropriate only for those investors who have the financial sophistication and expertise to evaluate the merits and risks of an investment in a fund and for which the fund does not represent a complete investment program. Please see end of report for important definitions and disclosures.

Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Foreign investing has additional risks including those associated with currency fluctuation, political and economic instability, and different accounting standards. These risks are heightened in emerging markets. Small- and mid-cap stocks are generally more volatile, subject to greater risks and are less liquid than large company stocks. Bonds are subject to market, interest rate, price, credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates. High yield (junk) bonds have lower credit ratings and are subject to greater risk of default and greater principal risk. The commodities markets are considered speculative, carry substantial risks, and have experienced periods of extreme volatility. Investing in a volatile and uncertain commodities market may cause a portfolio to rapidly increase or decrease in value which may result in greater share price volatility. Real estate has special risks including the possible illiquidity of underlying properties, credit risk, interest rate fluctuations and the impact of varied economic conditions.

Sector investing can be more volatile than investments that are broadly diversified over numerous sectors of the economy and will increase a portfolio’s vulnerability to any single economic, political, or regulatory development affecting the sector. This can result in greater price volatility. Communication services companies are vulnerable to their products and services becoming outdated because of technological advancement and the innovation of competitors. Companies in the communication services sector may also be affected by rapid technology changes; pricing competition, large equipment upgrades, substantial capital requirements and government regulation and approval of products and services. In addition, companies within the industry may invest heavily in research and development which is not guaranteed to lead to successful implementation of the proposed product. Risks associated with the Consumer Discretionary sector include, among others, apparel price deflation due to low-cost entries, high inventory levels and pressure from e-commerce players; reduction in traditional advertising dollars, increasing household debt levels that could limit consumer appetite for discretionary purchases, declining consumer acceptance of new product introductions, and geopolitical uncertainty that could affect consumer sentiment. Consumer Staples industries can be significantly affected by competitive pricing particularly with respect to the growth of low-cost emerging market production, government regulation, the performance of the overall economy, interest rates, and consumer confidence. The Energy sector may be adversely affected by changes in worldwide energy prices, exploration, production spending, government regulation, and changes in exchange rates, depletion of natural resources, and risks that arise from extreme weather conditions. Investing in the Financial services companies will subject an investment to adverse economic or regulatory occurrences affecting the sector. Some of the risks associated with investment in the Health Care sector include competition on branded products, sales erosion due to cheaper alternatives, research and development risk, government regulations and government approval of products anticipated to enter the market. There is increased risk investing in the Industrials sector. The industries within the sector can be significantly affected by general market and economic conditions, competition, technological innovation, legislation and government regulations, among other things, all of which can significantly affect a portfolio’s performance. Materials industries can be significantly affected by the volatility of commodity prices, the exchange rate between foreign currency and the dollar, export/import concerns, worldwide competition, procurement and manufacturing and cost containment issues. Real estate investments have special risks, including possible illiquidity of the underlying properties, credit risk, interest rate fluctuations, and the impact of varied economic conditions. Risks associated with the Technology sector include increased competition from domestic and international companies, unexpected changes in demand, regulatory actions, technical problems with key products, and the departure of key members of management. Technology and Internet-related stocks, especially smaller, less-seasoned companies, tend to be more volatile than the overall market. Utilities are sensitive to changes in interest rates, and the securities within the sector can be volatile and may underperform in a slow economy.

Alternative investments, such as hedge funds, private equity/private debt and private real estate funds, are speculative and involve a high degree of risk that is appropriate only for those investors who have the financial sophistication and expertise to evaluate the merits and risks of an investment in a fund and for which the fund does not represent a complete investment program. They entail significant risks that can include losses due to leveraging or other speculative investment practices, lack of liquidity, volatility of returns, restrictions on transferring interests in a fund, potential lack of diversification, absence and/or delay of information regarding valuations and pricing, complex tax structures and delays in tax reporting, less regulation and higher fees than mutual funds. Hedge fund, private equity, private debt and private real estate fund investing involves other material risks including capital loss and the loss of the entire amount invested. A fund's offering documents should be carefully reviewed prior to investing.

Hedge fund strategies, such as Equity Hedge, Event Driven, Macro and Relative Value, may expose investors to the risks associated with the use of short selling, leverage, derivatives and arbitrage methodologies. Short sales involve leverage and theoretically unlimited loss potential since the market price of securities sold short may continuously increase. The use of leverage in a portfolio varies by strategy. Leverage can significantly increase return potential but create greater risk of loss. Derivatives generally have implied leverage which can magnify volatility and may entail other risks such as market, interest rate, credit, counterparty and management risks. Arbitrage strategies expose a fund to the risk that the anticipated arbitrage opportunities will not develop as anticipated, resulting in potentially reduced returns or losses to the fund.

Bloomberg U.S. Corporate Index is designed to measure the performance of U.S. corporate bonds that have a maturity of greater than or equal to 10 years.

S&P 500 Index is a market capitalization-weighted index composed of 500 widely held common stocks that is generally considered representative of the US stock market.

PitchBook growth equity index tracks the performance of growth equity funds, offering a benchmark for investors to monitor trends in this investment strategy. PitchBook defines growth equity as minority (non-control) equity investments in more mature companies with proven models to fuel expansion, rather than early-stage startups or taking control through leveraged buyouts.

S&P 500 Index is a market capitalization-weighted index composed of 500 widely held common stocks that is generally considered representative of the US stock market.

An index is unmanaged and not available for direct investment.

Investment Grade bonds - A rating that indicates that a municipal or corporate bond has a relatively low risk of default. Bond rating firms, such as Standard & Poor's, use different designations consisting of upper- and lower-case letters 'A' and 'B' to identify a bond's credit quality rating. 'AAA' and 'AA' (high credit quality) and 'A' and 'BBB' (medium credit quality) are considered investment grade. Credit ratings for bonds below these designations ('BB', 'B', 'CCC', etc.) are considered low credit quality, and are commonly referred to as "junk bonds".

Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.

The information in this report was prepared by Global Investment Strategy. Opinions represent GIS’ opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report.

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