Investors have gotten good news lately. The U.S. stock market reacted positively to a stable unemployment rate of 4.1 % in June 2025, which was lower than the expected 4.3%.
A dip in the Consumer Price Index (a metric used to gauge inflation) from 3.3% in May 2024 to 2.4% in May 2025 helped alleviate concerns about inflation. The Federal Reserve held its benchmark interest rates steady between 4.25% and 4.50% in June 2025, while the next rate cut is likely scheduled for September 2025.
Against the backdrop of encouraging economic numbers and reduced concerns about tariff wars, the benchmark S&P 500 (^GSPC 0.14%) index hit record highs.
Despite the current market optimism, picking stocks based solely on a few economic metrics can be risky. Instead, investors should consider data across various aspects of the economy -- such as employment, inflation, and production -- and make sure they aren't missing the bigger picture.
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Economic metrics can be deceptive
Consider the employment rate in June 2025. Although it appears healthy, the economy is currently facing critical problems, including a decline in overall labor force participation and slower job creation. The labor force participation rate has fallen to 62.3%, the lowest it has been since late 2022. Private sector nonfarm payrolls increased by only 147,000 jobs in June 2025, far lower than the 180,000 to 200,000 jobs per month estimated to be required to maintain growth in the working-age population.
While inflation appears to be under control based on headline CPI numbers, the core CPI (excluding food and energy) rose 2.9% for the 12 months ending in May 2025. Inflation persists in areas such as insurance, medical services, and housing.
Industrial production numbers are also mixed. While manufacturing grew 4.8% in the first quarter of 2025, manufacturing production declined by almost 0.5% in April, primarily due to a decline in motor vehicle output. Manufacturing output rose just 0.1% in May 2025, as an increase in motor vehicle and aircraft output was offset by weakness in other areas.
So, does the economy seem strong enough to match the market exuberance? I don't think so.
Analyzing historical case studies
To demonstrate how relying on lagging indicators alone can prove problematic for investors' portfolios, we can analyze two specific case studies.
In June 2020, a record jobs report showed that 4.8 million nonfarm payroll jobs were added and unemployment had dropped to 11.1% from the expected 12.4%, sending the markets soaring. Investors were optimistic, anticipating a strong rebound in the coming months following the pandemic-related lockdowns. However, the market exuberance was short-lived, as megacap tech stocks primarily experienced a dramatic decline in September 2020.
Wall Street had overlooked the acceleration of COVID-19 cases in certain key states and low overall consumer confidence. The jobs report was also based on data collected during the initial reopenings, which included the temporary rehiring of workers and did not account for job suspensions and rollbacks in regions experiencing a resurgence in COVID-19 cases. The challenging macroeconomic conditions raised concerns about the tech stock valuations being too high.
Then, in March 2023 markets surged due to cooler-than-anticipated inflation numbers and increased expectations that the Federal Reserve would ease its aggressive interest rate hiking. This led to capital flowing into rate-sensitive sectors such as technology, consumer discretionary, and communication services.
However, while the headline CPI was cooling down, shelter costs increased month over month by 0.6% in March 2023. Although this was the smallest monthly gain since November 2022, it still resulted in an 8.2% year-over-year rise in shelter costs. Additionally, the March 2023 CPI reading of 5% was still 2.5 times the Federal Reserve's target of 2%.
Hence, contrary to market expectations, the Federal Reserve delivered its 10th consecutive interest rate hike in May 2023, raising the benchmark rate to 5%-5.25%, the highest since August 2007. Not surprisingly, the very sectors that had benefited from the March rally, including housing stocks and fintech companies, suffered the most after the rate hikes were announced.
These case studies highlight the importance of thoroughly examining lagging indicators to comprehend the investment landscape accurately.
Stocks for the current cautious economic environment
In this environment of a softening labor market, with declining job openings, reduced labor force participation, and persistent uncertainty surrounding tariffs, it makes sense to take stakes in fundamentally strong companies with recurring revenue streams and high pricing power.
Leading cloud and enterprise software player Microsoft (MSFT -0.01%) could prove to be a smart pick in periods of economic ambiguity thanks to its diversified business model, recurring revenue streams, and strong balance sheet. The company plans to invest $80 billion in AI infrastructure and data centers in fiscal 2026 (ending June 30, 2026), aiming to capture a significant share of the AI market, which is estimated to be worth nearly $1.8 trillion by 2032.
Microsoft's increasingly dominant AI ecosystem, which includes Azure AI services, Copilot virtual assistant integrated across its various software offerings, and AI-powered personal computers, is expected to be a significant growth catalyst even in a challenging market environment.
Custom data center chip and advanced networking infrastructure provider Broadcom (AVGO 0.48%) is another stock that is benefiting dramatically from the ongoing AI infrastructure boom. The company's AI-related revenues surged 46% year over year to $4.4 billion in the second quarter of fiscal 2025 (ending May 4, 2025). Broadcom's AI networking business also grew over 170% year over year in the second quarter, capturing 40% of total AI revenue.
Analysts expect the company's AI revenue to be $15 billion to $18 billion in fiscal 2025, driven by rising demand for large AI clusters from its existing three major hyperscaler clients, as well as the addition of new hyperscaler customers. Furthermore, Broadcom's $61 billion acquisition of VMware has also strengthened the company's position in the hybrid cloud and networking software space.
Do your homework
Relying on economic headlines for investment decisions can prove harmful in the long run. Instead, it makes sense to triangulate economic data and pick stocks that have low downside risk in the current environment. By avoiding potential traps, you can build a solid portfolio for long-term wealth generation.
