This earnings season has delivered a blockbuster surprise from US corporations. S&P 500 second-quarter profits surged 31% year-over-year, far exceeding Wall Street's 23% forecast and marking the strongest growth since Bloomberg Intelligence's tracking began in 1992, excluding recovery periods following major recessions. With over 90% of index members having reported, the first-half profit performance is on track to be the best since the same period in 2021. The momentum is driven by two forces: the accelerating penetration of artificial intelligence (AI) compressing costs and boosting margins, while the US economy has shown unexpected resilience amid multiple headwinds, including energy price spikes triggered by the Iran conflict. "Given the current macro backdrop, this result is all the more striking," said Marta Norton, Chief Investment Strategist at Empower.

AI Transforms from 'Cost Center' to 'Profit Center'

The net profit margin of S&P 500 members, which had long struggled to break the 14% threshold, is now approaching 16%. Mark Hackett, Chief Market Strategist at Nationwide Funds Group, pinpointed the turning point: "Over the past five years, AI was a cost center for most companies, with only hyperscale cloud providers benefiting from stock price gains. This year marks an inflection point—AI is truly becoming a profit center." 22V Research estimates that AI has boosted profit margins by about 150 basis points. The technology sector still holds the highest margins in the S&P 500, but a growing number of companies from other industries are also beginning to quantify AI's benefits in earnings calls. This trend is not limited to the US. According to Deutsche Bank data, European companies' second-quarter net profit margins hit a record 12%. Bloomberg Intelligence data shows that European executives mentioned AI an average of over four times during earnings calls, a historic high, far above the average of 0.5 times since 2016. "Quantifiable cost and efficiency gains have become a central topic, with more management teams discussing realized benefits," noted Emmanuel Cau and other strategists at Barclays.

Tech Sector Divergence: Who is Delivering AI Returns?

This earnings season has also drawn a clear line within the tech sector: companies that can demonstrate AI investments are generating cash returns are rewarded by the market, while those that cannot are penalized. Marta Norton pointed out, "Cloud business may be the clearest signal." She highlighted the strong performance of Amazon and Microsoft, both of which beat expectations for their cloud operations. In contrast, Meta Platforms (Facebook's parent) saw its stock price plunge after issuing revenue guidance considered disappointing by the market, only recently recovering some ground. The earnings report for chip giant Nvidia, yet to be released, will be a major focus for the market this month.

Valuation Compression as Earnings Do the Heavy Lifting

Earnings growth has outpaced the index's price gains, leading to a key shift: valuation compression. The S&P 500's price-to-earnings ratio has fallen from about 26 times at the start of the year to below 22 times. One of the market's biggest concerns earlier this year was overvaluation, and this risk is now being absorbed by profit growth. "We've experienced a nice reset, making valuations more attractive," said Keith Lerner, Chief Investment Officer and Chief Market Strategist at Truist Advisory Services. Even the technology sector, which has seen profit growth exceeding 20% for seven consecutive quarters, has seen its valuation multiple decline. Given uncertainty over the Federal Reserve's policy outlook and energy prices, Lerner believes tech valuations are unlikely to return to their previous highs. "Right now, earnings are doing the heavy lifting, not valuation expansion," wrote Scott Rubner, Head of Equity and Derivatives Strategy at Citadel Securities. "The magnitude of earnings upgrades is almost unprecedented—you don't see double-digit upgrades outside of recovery periods," said Grace Peters, Co-Head of Global Investment Strategy at JPMorgan Private Bank, on Bloomberg TV.

Broadening Profit Growth: Not Just a Large-Cap Story

Wall Street strategists are optimistic about the sustainability of earnings growth, citing its breadth across nearly all sectors—healthcare is the only S&P 500 sector experiencing profit contraction. According to Bespoke Investment Group, as of August 12, about three-quarters of the roughly 1,500 US-listed companies that have reported beat both earnings per share and revenue expectations. "This story has moved beyond mega-cap stocks," said Ed Clissold, Chief US Strategist at Ned Davis Research, noting that the beat rate for small and mid-cap stocks is near post-pandemic highs. "This earnings season shows positive breadth, which typically means the same momentum will continue," said Rob Haworth, Senior Investment Strategy Director at US Bank Wealth Management.

Global Synchrony: Europe and Asia-Pacific Strengthen in Tandem

The earnings improvement is not unique to the US. Bloomberg Intelligence data shows that second-quarter profits for MSCI Europe Index components rose 18% year-over-year, the best performance since 2022. Cyclical sectors like energy, materials, and industrials have contributed significantly, driving the Stoxx Europe 600, Germany's DAX, and France's CAC 40 to successive record highs. "The European macro story is undeniably improving, and this is happening while market positioning remains low to neutral, painting a positive picture for equities," said Benedicte Lowe, Equity Derivatives Strategist at BNP Paribas, on Bloomberg TV. Barclays analysis also found that the proportion of European companies raising guidance has hit a four-year high, with management confident in sustaining high margins. The Asia-Pacific region is also keeping pace. Since June, earnings forecasts for the MSCI Asia Pacific Index have been revised up by nearly 10%, the largest gain for the same period since 2009. Asian financial stocks just recorded their strongest monthly outperformance relative to the MSCI Asia Pacific Index since 1998. "The AI theme is still dominant, especially in semiconductors, but investors are increasingly looking beyond obvious chip stocks—to non-chip AI beneficiaries, financials, and other lagging sectors with less valuation pressure," said Rajeev De Mello, Global Macro Portfolio Manager at Gama Asset Management.

Outlook: Strategists Raise Target Prices

The robust earnings performance is prompting Wall Street strategists to raise their year-end targets for the S&P 500. The average forecast now stands at 7,894 points, implying about 1% upside from the index's record high this week. Analysts have also lifted their full-year earnings growth estimate for the S&P 500 to 27%, up from 15% at the start of 2026. Nvidia's earnings report will be the final major piece of the puzzle this month, and its results will likely test the strength of this profit-driven bull market.