U.S. earnings are exceptional. Stocks are playing catch-up.

Why so strong?

The second-quarter earnings season has delivered one of the strongest fundamental backdrops of the post-pandemic cycle. Earnings growth at this pace is typically a phenomenon seen at the start of an economic expansion, occurring most often as the economy rebounds post-recession. But not this time, thanks to a once-in-a-generation capital expenditure boom, tax policies, a spike in energy prices and pent-up demand.

The biggest driver is the artificial intelligence infrastructure build-out. Semiconductor, networking and cloud-related spending continues to expand as hyperscalers race to deploy capacity. Capital expenditure expectations for the largest technology companies are expected to cross over $1 trillion in 2027, as investor speculation shifts from whether spending will continue to how long supply constraints will persist. That shift demonstrates renewed faith in the AI trade that’s driving semiconductor sales higher by over 66% year-over-year and tech revenue up 21%. AI-related spending is also increasingly generating secondary benefits across industrials, utilities, logistics, construction and other areas connected to the buildout of digital infrastructure.
 
But it’s not AI alone. Energy has also played an important role. Elevated oil and gas prices following the conflict in Iran have provided a substantial earnings tailwind for the sector. Earnings per share for the energy sector rose 71% year-over-year, the highest since 2022. And in the Financials sector, near-record trading revenue and a revival in investment banking is yielding a wave of mergers and acquisitions and a busy initial public offering (IPO) calendar.

Record profitability across sectors has pushed the S&P 500’s margins to historic highs, allowing earnings growth to significantly outpace revenue growth. And the fact that all 11 sectors are growing revenue signals a still-resilient consumer and provides the cleanest “the economy is still growing” signal—crucial for investors concerned about concentrated growth and risk.

Battling other forces

Years of worry around rate and recession risk are still being worked through. Despite the strong earnings fundamentals, investors are still digesting other factors. Elevated oil prices as a result of the ongoing conflict in Iran and bond yields inching higher are in part keeping stocks capped in the short-term. The way that manifests is in the response to earnings beats, which have generated less upside than usual, even as underlying results continue to surprise positively, and any misses are punished more severely.

Some of those headwinds may be beginning to ease, as oil prices retreat and signs of stabilization in long-end yields potentially reduce pressure on valuations. The larger concern is around the sustainability of the AI build-out.

The hyperscalers and semiconductor companies have demonstrated clear demand for compute and chips, but the durability of the AI cycle depends on whether customers can prove the economic benefits of deploying those tools.

There is no doubt that adoption of the technology is broadening across industries, with more companies citing productivity improvements. But only a small percentage have reported a meaningful impact on their earnings. That gap may represent one of the most important metrics for investors over the next year. A meaningful acceleration in those metrics would provide the clearest signal that the current infrastructure build-out will indeed generate lasting economic returns.

For now, the fundamental story remains intact. Earnings continue to exceed expectations, margins remain near record highs and AI investment shows few signs of slowing. Should bond yields become less of a headwind and more conviction emerges in the long-term productivity benefits of AI, the stock market can catch up to reflect the strong earnings growth expected going forward.