Stock rally hinges on AI as $1.2 trillion capex question looms

The S&P 500's 10.2% year-to-date gain now depends more on AI spending than oil, a shift that leaves the rally vulnerable to any hesitation in Big Tech's $1.2 trillion capex buildout. The index closed at 7,543.64, up 20.1% over the past year.

"The market's earnings story is being powered by AI investment, which is why it's arguably the biggest factor driving the rally," said Andrew Sheets, chief cross-asset strategist at Morgan Stanley. "Investors have become a lot less patient with heavy capex and uncertain returns."

S&P 500 Q2 2026 earnings are expected to rise 23.3%, up from an 18.8% estimate on March 31, FactSet data shows. The AI-heavy Information Technology sector leads with 63.3% earnings growth, while tech earnings estimates jumped 9.9% to $223.6 billion, helped by Micron, Nvidia, Apple and Sandisk. Wall Street targets range from Citigroup's 8,100 to J.P. Morgan's 7,800, with Goldman Sachs and Morgan Stanley at 8,000 and Wells Fargo at 7,950. Morgan Stanley also has a separate 12-month target of 8,300 tied to earnings strength.

The risk emerges as Q2 earnings season begins this week. Morgan Stanley expects AI investment to jump from nearly $800 billion in 2026 to roughly $1.2 trillion in 2027, a scale that has fed demand for chips, data centers, cloud infrastructure and power. But some major AI spenders have underperformed recently, Sheets noted, making investors less patient with heavy capex and uncertain returns. If hyperscalers signal slower spending, the pressure would spread well beyond chip stocks.

The thematic shift from energy to AI is reshaping sector allocation. The Information Technology sector's expected 63.3% earnings growth contrasts with energy sector estimates facing headwinds from potential oil price normalization. This divergence has driven fund flows toward tech-heavy indices, with the Nasdaq outperforming the Dow by a wide margin this year. For portfolio managers, the concentration of gains in a handful of AI-related names raises the stakes for earnings season — a miss from any major hyperscaler could trigger a broader selloff across growth stocks.

The bull case also depends on oil prices normalizing. Morgan Stanley's assumptions include maritime traffic through the Strait of Hormuz returning to pre-war levels and Brent crude dropping back toward $75 a barrel over the next 12 months. Any major escalation with Iran would undermine those assumptions, pushing transport and goods prices higher and forcing investors to rethink the soft-landing trade. A sustained oil spike would also complicate the Fed's path, as higher energy costs feed into inflation expectations and reduce the central bank's flexibility.

The rally is partly built on the belief that the Federal Reserve can keep rates steady through year-end. But the CME FedWatch tool shows an 82% chance of at least one hike by year-end. Bank of America expects three 25-basis-point increases, while Deutsche Bank forecasts 50 basis points of tightening, Reuters reported. Sticky inflation and a resilient labor market have fueled rate-cut skepticism, with BNP Paribas and Macquarie also among the minority expecting hikes. The Fed's latest minutes showed policymakers' inflation concerns had grown substantially, according to Reuters, adding another layer of uncertainty for equity investors.

This article is for informational purposes only and does not constitute investment advice.