Investors in the stock market are facing a protracted war in Iran, rising oil prices and a bond sell-off that could elevate borrowing costs across the economy.
And yet they are unfazed.
The benchmark S&P 500 index is up nearly 13 percent this year, and some analysts expect the market to end the year even higher.
What’s propping up investor optimism right now is a strong earnings season and enthusiasm around artificial intelligence, helping to overcome fears of inflation and the impact of rising interest rates.
But those gains may waver as markets wade through September, a month when, historically, stocks fall. There are also risks to the rally as interest rates keep rising and concerns about runaway spending on A.I. data centers mount.
What’s driving the market: A.I. and earnings
The exuberance around A.I. has been an omnipresent force in the market for more than a year — and it’s still delivering.
Blowout financial results posted by tech behemoths like Nvidia have only pumped stocks higher by showing that the demand for A.I. remains strong. While investors have become more selective, paying close attention to how much large tech companies — or “hyperscalers” — are spending on A.I., they are still betting that this costly build-out in computing infrastructure will eventually pay off.
The Nasdaq index, which is concentrated heavily in technology companies, is up around 14 percent this year.
The market’s optimism goes beyond A.I. Across the board, quarterly earnings reported by companies in recent weeks surpassed investors’ expectations, often by a wide margin.
Roughly 88 percent of the companies in the S&P 500 that had reported results for their most recent quarter by Aug. 31 beat expectations on their earnings per share, according to Scott Rubner, a Citadel Securities analyst. And those that missed expectations didn’t miss by much.
The S&P 500 is weighted by the market value of the companies in the index. That means the index’s performance is heavily skewed by a handful of technology companies that have the largest market values.
But even when equal weight is given to nontechnology companies in the index, the returns have been strong. The equal-weighted S&P 500 is up more than 13 percent this year, slightly higher than the returns on the standard index.
What explains this broad strength? Some sectors, like energy, have been boosted by high oil prices, helping them rake in bigger profits.
There’s also a tariff-related tailwind. Since the U.S. Supreme Court struck down a slew of tariffs on imported goods in February, the Trump administration has had to refund tens of billions of dollars collected from American companies.
The refunds provided a huge boost to some companies in the second quarter. Kohl’s received a tariff refund totaling about $100 million, according to analysts at Goldman Sachs. Lowe’s and Smuckers were others that benefited significantly from the refunds.
And then there were earnings that were lifted by A.I.
“You’re starting to see the broadening out now,” said Antony Ghee, head of equity investments for the chief investment office at Merrill and Bank of America Private Bank. “Early on in the cycle, it was certainly a lot about hyperscalers, but now we’re starting to see a lot of companies who are implementing A.I. into their processes.”
Barclays analysts estimated that 46 percent of all companies had discussed A.I. “substantively” on their second-quarter earnings calls, and that 30 percent had done so in the “context of revenue impacts, cost reductions, dollar-value benefits or operational efficiencies.”
What could derail the rally: Rising rates
Rates on government bonds have been ticking higher. And if they keep rising, they could cast a cloud over the stock market.
Higher-yielding bonds offer investors a strong return but with less risks than stocks. That’s one reason rising bond rates often push down stock values, as investors rethink the risks-reward of stocks versus bonds.
“When the yields are high, stocks look relatively unattractive all of a sudden, especially stocks where most of the earnings are in the future,” Thierry Wizman, a fixed-income and rates strategist for Macquarie Group.
As rates on government bonds go up, they also increase borrowing costs for companies that use debt to keep growing.
Currently, the 10-year Treasury note, a benchmark for interest rates across the economy, is at 4.78 percent.
“The greatest near-term concern for stocks is if you start seeing a sustained push above 5 percent,” Mr. Ghee of Bank of America said. “That’s when you should start seeing some concerns around corporate earnings being impacted.”
Investors have also become more touchy about anything’s going awry in the A.I. story. That means becoming more perceptive to how much companies are spending on A.I. projects and whether those investments will translate into profits. When Google released a solid earnings report in July, for example, its stock dipped after a higher-than-expected spending forecast.
Higher Treasury yields play into the A.I. sensitivity as well. Treasury rates are rising as the government seeks to entice investors to look past the federal deficits and keep buying its debt. But that could drive up rates the A.I. companies have to pay their investors in order to get them to continue buying the bonds the companies are selling to finance their growth.
“If the deficit does not get reduced, the deficit will crowd out bond issuance by corporations that will crowd out investment in A.I.,” Mr. Wizman said.
In a recent note, strategists at Evercore called 5 percent yields on the 10-year Treasury a “threat to the Structural ‘AI Revolution’ Bull Market.”
The stock market faces other challenges in the coming months. As the boosts from the tariff refunds wear off, the underlying picture for some companies, especially those exposed to the American consumer, looks more muddled. Walmart and Kohl’s, for example, said their customers were under pressure from higher gas prices, but both companies raised their earnings outlooks for the rest of the year.
There is also a changing of the seasons. As the calendar turns to September, stocks are entering the most challenging month for equities. It’s a window when a lot of investors sell stocks to rebalance their portfolios.
Since 1928, September is the only month in which the S&P 500 has finished lower more often than higher, according to Mr. Rubner of Citadel.
“These patterns are worth watching,” analysts at LPL Financial wrote in a recent research note. “When a behavioral tendency persists across decades, it can offer a useful sense of the prevailing wind.”
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