How AI Earnings Could Make or Break the S&P 500’s Rally

Google parent Alphabet is likely to spend nearly $160 billion on data centers and AI projects over the next two years. (Courtesy Google)

The stock market’s most powerful bullish theme faces a series of litmus tests over the next two weeks that could define broader performance over the second half of the year, starting with Google parent Alphabet’s second-quarter earnings update on Wednesday.

The Magnificent Seven stocks, which include major tech firms Alphabet, Microsoft, Tesla , Meta Platforms, Amazon.com, Apple, and Nvidia , comprise around a third of the S&P 500 ’s total market value. Shares of those companies have collectively surged more than 41% since their early April lows, nearly double the advance of the benchmark.

Nearly a third of the estimated $536.3 billion in collective profit from S&P 500 companies in the second quarter will come from just two sectors: information technology and communications services. The former category is dominated by artificial intelligence giants Nvidia, Apple, Microsoft, and Oracle. Alphabet and Meta lead the latter.

Most of those companies are pegging their near-term growth prospects to the development of AI technologies, and are spending billions in the race to ensure they establish a dominant position in this nascent market.

Often described as hyperscalers, companies such as Google, Microsoft, Amazon, and Meta have committed vast amounts of cash to build out the data centers they can then use to sell AI-powered products to their clients.

They’re also using the training and inferencing from their AI applications to enhance their own business models, from sharpening the accuracy of ad sales to expanding the utility of software products.

For Amazon, Google, Meta, and Microsoft, as well as rising star Oracle, that capital spending is likely to surge by around 41% to $369 billion this year, according to Bank of America data. That dwarfs the 4% growth rate expected for the other 493 companies in the benchmark.

Justin Post, BofA’s internet analyst, sees Google’s capital spending—a metric that illustrates how much companies are investing in AI, as well as other big-ticket projects—rising 44% from 2024 levels to $75.7 billion this year, then slowing to around 15% in 2026.

The pace of that spending for the biggest hyperscalers is forecast to slow next year, according to data from Bank of America, which could suggest concern that the biggest tech companies aren’t yet generating profit from the bulk of their AI investments.

That alone may not halt the S&P 500’s rally. BofA says that the overall capital spending commitments are likely to prove more important to overall gains.

“AI capex is a bigger tailwind for the market than idiosyncratic AI monetization,” said BofA’s head of U.S. equity strategy Savita Subramanian.

Microsoft, Amazon, and Meta will publish June quarter updates next week and will provide further checks on whether investments in AI are still going strong.

Subramanian sees the fruits of that spending impacting sectors well beyond tech, driving gains in stocks across the board. That could potentially support a wider rally for stocks over the near- to medium-term, as the narrow market leadership of the tech sector has been a major investor concern.

“Semis are the most obvious beneficiaries, but increased power usage from AI and the physical buildout of data centers should also lead to more demand for electrification, construction, utilities, commodities, etc., ultimately creating more jobs,” she added.

BlackRock’s Investment Institute, meanwhile, argues that AI will ultimately transform software, healthcare, fintech, and manufacturing as it becomes more widely adopted.

“AI intersects with multiple mega forces, including the energy transition, geopolitical fragmentation and the healthcare needs of aging societies,” the BlackRock Institute team, led by Jean Boivin, wrote in a recent outlook.

“The competition among the mega cap tech hyperscalers rushing to advance their AI models is as intense as ever,” the team added. “Hyperscalers are sticking with increased capital spending—and being rewarded for it.”

Richard Saperstein, chief investment officer at the New York-based investment Treasury Partners, is also a believer in the “data center ecosystem” that is developing from AI investments.

He sees utilities as another way investors can play the spending commitments from the biggest hyperscalers, a move that is already evident in some indexes. The S&P 500 utilities sector has gained around 8.2% over the past six months, outpacing the 3.6% advance for the broader benchmark over the same period.

“As data infrastructure grows, increased electricity generation, a modernized grid, additional construction, more GPUs, and enhanced cooling equipment will be required, and utilities are a prime beneficiary of this dynamic,” he said.

Dan Ives of Wedbush, a longtime advocate of the AI investment thesis, sees the spending trend continuing.

“Our bullish view is that investors are still not fully appreciating the tidal wave of growth on the horizon from the $2 trillion of spending over the next three years,” he said in a recent client note that said the breadth of that commitment extends well beyond direct purchases from AI chip leader Nvidia.

“We are starting to see the 2nd/3rd/4th derivatives of AI now start to play out,” he added. “For every $1 spent with Nvidia we estimate the multiplier is another $8 to $10 spent throughout the rest of the tech ecosystem as this AI Revolution marches ahead.”

In the same way that electrification powered the Second Industrial Revolution in the late 1800s, and the internet hyper-charged the tech sector a century later, AI is poised to define the global economy for decades to come. Markets will rely on its transition from concept to reality, powered by the billions in planned spending, to reap the rewards.

Write to Martin Baccardax at martin.baccardax@barrons.com