The Unseen Driver of AI’s Sustained Rally: Can Earnings Growth Really Save It?

The remarkable performance of artificial intelligence-linked stocks in 2026 has left many investors perplexed. With over 80% of the S&P 500’s gains attributed to these high-flying shares, concerns about a potential bubble have been mounting. However, strategists at Jefferies are convinced that the rally remains fundamentally supported by strong earnings growth, rather than speculative fervor.

Earnings expansion is often cited as a key driver of stock market performance, and AI-linked stocks appear to be no exception. According to Jefferies’ quantitative strategy team, gains across its AI-focused stock basket are being driven primarily by earnings expansion, rather than valuation multiple inflation. This dynamic suggests that the rally may be sustainable.

Forward earnings estimates for Jefferies’ AI basket have climbed by more than 30% since mid-2025. Consensus analyst forecasts currently point to an earnings-per-share compound annual growth rate of 38.5% for 2026 and 2027, a staggering figure that dwarfs the 11.9% growth rate expected from sectors outside the AI theme. This is not merely a case of valuation inflation – AI-linked stocks are trading at approximately 25 times forward earnings, below their historical one-standard-deviation threshold.

The implications of this trend are far-reaching. As Desh Peramunetilleke and his team observe, “AI is the cheapest sector to own in the U.S.” on a PEG basis. This may come as a surprise given the feverish attention lavished on AI stocks over the past year or so. The cheap valuation has allowed AI-linked shares to outperform their broader market counterparts.

Within the AI sector itself, returns have varied significantly in 2026, with companies tied to AI servers, optical components, and memory technologies delivering the strongest gains. In contrast, hyperscalers and chip designers have underperformed relative to other AI sub-sectors.

Despite the strong earnings outlook for the AI sector, some stocks are more attractive than others from a valuation perspective. Memory and compute-related stocks currently appear most attractive when measured by PEG ratios, while semiconductor equipment manufacturers and chip design firms are viewed as relatively expensive.

The latest earnings season provided additional support for the AI investment case, with around 86% of companies delivering earnings results above analyst expectations. This marks the strongest beat rate since the post-pandemic period and improves from 75% in the previous quarter. Revenue beats also rose to 82%.

However, positive earnings surprises did not consistently translate into stronger share price performance across the broader market. Outside AI and a limited number of other sectors, stocks generally failed to outperform following earnings beats, while companies missing expectations were punished heavily – reflecting elevated investor expectations.

As investors look ahead, it’s essential to remain vigilant in their analysis of the AI sector. The rally may be sustained by strong earnings growth, but that doesn’t necessarily mean continued success is guaranteed. Investors must keep a close eye on valuation multiples and performance within the sector.

Ultimately, Jefferies’ conviction in the AI investment case is founded on robust data and sound analysis. Whether or not the rally continues remains to be seen – but one thing is certain: investors would do well to pay close attention to this sector’s evolving dynamics, lest they find themselves caught out by an unexpected turn of events.