After a rocky start to 2025, the second quarter delivered a powerful rebound in U.S. equities. The S&P 500 surged 10.6%—its best quarterly showing in over a year—erasing Q1’s losses and pushing to new record highs by the end of June. The mood shift was driven by cooling inflation, steady employment, and growing conviction that interest rates may have finally peaked.

Inflation Cools, Confidence Returns

Throughout the quarter, economic data gradually painted a more encouraging picture. Inflation, though still above the Federal Reserve’s long-term goal, continued to moderate—giving investors breathing room to revisit growth-oriented strategies. Employment data firmed modestly, and consumer sentiment improved despite continued strain in credit markets and housing affordability.

The Fed held rates steady, and while officials reiterated the “higher-for-longer” mantra, markets interpreted their tone as more balanced. Rate cut expectations firmed for late 2025, fueling a broad rally in equities—especially in tech and cyclical sectors.

Winners and Losers: A Tale of Divergence

Despite the strong headline number, the rally wasn’t evenly distributed. Growth stocks roared back to life, while more defensive areas struggled to keep pace.

• Technology (+22.8%) was the star performer. AI enthusiasm returned in force, and demand for cloud services and hardware reignited investor appetite despite lofty valuations.
• Industrials (+12.9%) rode momentum from infrastructure spending, strength in aerospace, and easing supply chain disruptions.
• Communication Services (+12.8%) rebounded sharply, led by gains in digital media, streaming, and advertising platforms.
• Consumer Discretionary (+10.3%) benefited from strong travel trends and surprising retail resilience.

More modest gains came from:

• Financials (+5.5%), supported by wider lending margins and stable credit quality.
• Utilities (+4.3%) and Materials (+2.6%), helped by lower input costs and a modest return to defensive allocations.

But the quarter wasn’t kind to every sector:

• Real Estate (-0.1%) and Consumer Staples (-0.2%) hovered around flat, as investors rotated away from income-oriented names.
• Health Care (-7.2%) slumped on weak earnings from major pharmaceutical names and lingering regulatory pressures.
• Energy (-8.5%) was the quarter’s biggest laggard. Oil prices slipped back, and natural gas demand softened following a mild winter and high inventory levels.

Looking Ahead: Selectivity Over Safety

Q2’s rally reminded investors that leadership in this market continues to rotate. Tech is back in the driver’s seat, but volatility remains under the surface. As valuations climb, particularly in AI and semiconductor names, Q3 will test whether earnings can justify the optimism.

The outlook isn’t all sunshine. Sticky inflation, policy uncertainty, and geopolitical risk could bring defensive sectors back into favor quickly. That makes sector agility and company-specific fundamentals more important than ever.

Bottom line: The second quarter was a clear vote of confidence in a soft-landing scenario. But with dispersion widening and policy risks still lurking, successful investors will need to be nimble—not just bullish.