The U.S. equity market extended its rally this week, with the S&P 500 recording its first record closing high in two months on Tuesday. Investors point to an unusually strong corporate profit backdrop, a rebalancing of high-flying AI-related stocks, and valuations that have become more tempered as reasons the advance can continue.
Market participants said the current earnings season has been central to the optimism, with results so far exceeding already lofty expectations and underpinned by heavy investment in AI infrastructure. Still, strategists cautioned that higher Treasury yields and seasonal political risks could restrain further gains.
Earnings and AI capex drive sentiment
With more than 75% of S&P 500 companies having reported, adjusted second-quarter earnings are on track to rise 31.1% from a year earlier, according to LSEG IBES data as of Wednesday. That would mark the strongest year‑over‑year growth rate since 2021. Analysts noted that estimates for the third and fourth quarters have also moved up modestly in recent weeks.
The technology sector has been a major contributor to the earnings surge. Second-quarter tech earnings were projected to increase roughly 72%, and overall earnings growth was expected in 10 of 11 S&P 500 sectors, LSEG data showed.
Much of the earnings momentum has been attributed to massive capital expenditures by hyperscale cloud providers and other large enterprise buyers of AI infrastructure. Goldman Sachs strategists estimated that capital spending by the hyperscalers plus Oracle could approach nearly $800 billion this year. Investors said that the combination of hyperscaler spending and the resulting semiconductor demand creates a powerful feedback loop across parts of the technology supply chain.
"The hyperscalers can work because they’re getting an ROI on their cloud business," said Eric Johnston, chief equity and macro strategist at Cantor. "But so can semis because ... the capex can continue. And it’s that combination which is super powerful right now."
AI trade recalibration and market breadth
While some AI-related names pulled back sharply from late-June peaks, many investors described the move as a healthy reset that has left the market in a more balanced position. The Philadelphia SE semiconductor index, which had been at elevated levels earlier in the summer, is still roughly 17% below its late-June high even as it remains more than 70% higher on the year.
"Now that we’ve gone through the selling pressure, you’re at a more balanced state around some of these key names that were rising in the second quarter," said Anthony Saglimbene, chief market strategist at Ameriprise. That rebalancing, market observers said, reduces the risk of an overheated narrow rally and improves the prospects for broader participation.
Valuations have softened amid stronger profits
Robust earnings growth has helped ease valuation pressures. The forward price-to-earnings ratio on the S&P 500 was 20.4 on Tuesday, according to LSEG Datastream, down from 22.2 at the end of 2025 and below the 21.3 level seen on June 2, when the index last hit a record. The tech sector’s forward P/E also moderated to 22.1 from 26.5 at the end of 2025.
"We’re in a pretty strong fundamental environment," Saglimbene said. "The valuations have gotten more attractive over the last month and a half."
Portfolio managers pointed to the breadth of earnings strength as another constructive sign. "Corporate profits have been spectacular," said Eric Kuby, chief investment officer at North Star Investment Management. "Earnings growth has been explosive in mega-cap technology and specific sectors, but it’s strong across the board."
Rising yields and oil weigh on upside
Despite the upbeat earnings backdrop, higher Treasury yields present a tangible risk for equities. The benchmark 10-year Treasury yield hit its highest level since January 2025 last week, a development that can make fixed income more competitive with stocks and raise borrowing costs for consumers and businesses.
More recently, the 10-year yield retreated to about 4.63% as tensions in the Middle East eased and oil prices came down, which in turn dampened near-term inflation concerns. "The fact that oil prices are now back below 80 (dollars a barrel) might go a long way in helping contain the rise in yields," said Angelo Kourkafas, senior global investment strategist at Edward Jones. He added, however, that investors would need to see sustained relief on that front before valuations can expand meaningfully.
Seasonality and politics add uncertainty
Another layer of caution comes from the calendar. Markets are moving into a seasonally challenging period ahead of the November midterm elections, which will determine control of the U.S. Congress. Historical averages in midterm years show that the S&P 500 has posted negative returns on average in both August and September, according to CFRA, a fact market participants are watching as they position portfolios.
Investors also noted that narratives around the AI trade can swing sentiment dramatically. "The sentiment shift around AI can be so severe," said Marta Norton, chief investment strategist at Empower. "Absent something coming out of left field, absent major concerns around the yield curve, we have a generally favorable backdrop for the back half of the year."
Outlook
Taken together, the mix of strong corporate profits, continued hyperscaler capex and more moderate valuations provides a supportive fundamental backdrop for equities in the near term. At the same time, elevated Treasury yields, potential volatility tied to AI narratives, and seasonally higher risks related to the election cycle leave room for caution.
Market participants say the path ahead will likely depend on whether earnings momentum persists, whether capex from large cloud providers continues to translate into durable demand for related suppliers, and how macro variables such as yields and oil prices evolve.