Assessing Sector Rotation in the S&P 500: Why Defensive Plays May Outperform in a Volatile Market

The S&P 500 has been a rollercoaster in 2025, with sector rotation painting a vivid picture of investor sentiment. While offensive sectors like Consumer Discretionary and Communication Services have dominated headlines, defensive sectors are quietly gaining traction as market volatility intensifies. This shift isn't just noise—it's a structural recalibration driven by macroeconomic pressures and geopolitical uncertainty. Let's break down why defensive plays could outperform in the months ahead.

The Offense-Defense Divide: A Tale of Two Sectors

Relative strength trends have long been a barometer for market psychology, and 2025 is no exception. According to a report by StockCharts, the “offense vs. defense” ratio—comparing sectors like Consumer Discretionary (offense) to Consumer Staples (defense)—has shown a persistent tilt toward offensive sectors, reflecting optimism about economic growth and discretionary spending Sector Rotation Suggests Offense Over Defense - StockCharts.com^[2]. However, this optimism is fraying at the edges.

Take the Utilities sector, for example. While it's been a laggard in 2025, its weakening position on the Relative Rotation Graph (RRG) suggests a potential reversal if volatility spikes Sector Rotation Suggests Offense Over Defense - StockCharts.com^[2]. This isn't just theoretical: During Q1 2025, defensive sectors like Healthcare, Consumer Staples, and Utilities outperformed the S&P 500, , , , respectively Charted: How Every S&P 500 Sector Performed in Q1 2025^[3]. These sectors thrived as investors fled high-risk growth stocks, seeking stability in essential goods, regulated utilities, and defensive healthcare services.

Geopolitical Shocks and the New Normal

The Israel-Iran conflict in 2025 offered a stark reminder of how geopolitical events can disrupt sector dynamics. The Energy sector, for instance, . Yet, over the long term, Energy and Aerospace & Defense have shown resilience. The latter, in particular, , driven by increased defense spending Research: How war moves markets – the performance of S&P 500 defense and energy sectors^[1]. This duality underscores a critical takeaway: while short-term volatility can punish cyclical sectors, defensive and semi-defensive industries often benefit from sustained government and institutional demand.

Meanwhile, trade tensions have added another layer of complexity. U.S. , but defensive sectors like Consumer Staples and Utilities held up remarkably well Q1 2025: Defensive Sectors Outperform Amid Rising Volatility^[4]. This isn't surprising—essential goods and services are less sensitive to trade wars, making them natural safe havens during risk-off rotations.

Momentum Shifts and Market Structure

The S&P 500's trailing 12-month performance reveals a mixed bag for defensive sectors. Consumer Staples, for instance, maintains a “Marketperform” rating but faces headwinds from inflation and higher tariffs Research: How war moves markets – the performance of S&P 500 defense and energy sectors^[1]. Utilities and Real Estate, meanwhile, have posted moderate gains but remain vulnerable to rising interest rates and weak commodity prices Research: How war moves markets – the performance of S&P 500 defense and energy sectors^[1]. These dynamics highlight a key truth: defensive sectors aren't immune to macroeconomic forces—they're just better positioned to weather them.

Relative strength analysis further reinforces this. While offensive sectors like Financials and Energy continue to attract capital, their momentum is increasingly at odds with the broader market's cautious tone Sector Rotation Suggests Offense Over Defense - StockCharts.com^[2]. This divergence is a red flag for investors. When offensive sectors outperform during periods of high volatility, it often signals a market top. Conversely, a rotation into defensive sectors can indicate a bottoming process.

The ETF Angle: Defensive Plays in Action

The ETF market has already priced in this shift. Defensive sector ETFs like the Health Care Select Sector SPDR (XLV), (XLP), and (XLU) have outperformed the SPDR S&P 500 ETF (SPY), . In contrast, aggressive tech-focused ETFs like the Vanguard Information Technology ETF (VGT) have lagged, . This stark contrast isn't just a short-term anomaly—it's a reflection of shifting investor priorities.

Looking Ahead: A Call for Caution

As we enter Q3 2025, the key question is whether this defensive rotation will accelerate. With trade tensions unresolved, consumer confidence waning, and interest rates still elevated, the odds favor defensive sectors. That doesn't mean ignoring offensive plays entirely—cyclical sectors will rebound when growth stabilizes. But in the near term, investors should prioritize capital preservation and income.