US Earnings: Is Software Back, and Is the Pricing-Up Narrative Over? A Guide to Understanding Capital Rotation

💡S&P 500 companies demonstrated exceptional performance in Q2 earnings, with 86% of companies reporting EPS above expectations, significantly surpassing the five-year average of 78% and the 10-year average of 76%. The magnitude of this earnings surprise reached a remarkable 29.2%, marking a new all-time high since FactSet began tracking this indicator in 2008. This broad-based outperformance signals a robust fundamental backdrop for US equities, as nearly 90% of constituents have reported strong results, reflecting a widespread positive trend across industries.

💡Technology sector earnings, particularly for Communication Services and Information Technology, performed exceptionally well in Q2, with Communication Services achieving 117.0% earnings growth and Information Technology following at 70.4%. CSP giants like Amazon AWS, Microsoft Intelligent Cloud, and Google Cloud reported revenue growth of 37%, 32%, and 82%, respectively, demonstrating AI monetization entering a harvest phase. Software companies also defied the "SaaS apocalypse" narrative, with Palantir's revenue reaching a record $1.94 billion, up 93% YoY, and Cloudflare reporting a more than 1,700% increase in daily AI Agent requests, indicating strong performance driven by AI demand.

💡Model profitability compression in the downstream software value, driven by intense pricing competition from Chinese open-source models like Moonshot AI's Kimi K3 and DeepSeek V4 Flash, is forcing frontier labs to implement defensive price cuts. While this compresses the intelligence premium in tokens and impacts the model layer's profit structure in the short term, it is ultimately beneficial for extending the productivity cycle and accelerating mature technological adoption. This compression shifts the focus to the application layer, which is demonstrating stronger performance, as evidenced by robust software company earnings, validating that lower model prices can unlock broader demand and new applications.

💡The Jevons Paradox explains increased AI demand despite lower model prices by demonstrating that when the cost of a resource (like "intelligence" per token) decreases, its overall consumption can increase significantly, unlocking much larger and broader latent demand and entirely new applications. The DeepSeek moment in early 2025, with lower model prices, led to continuous new highs in token usage on third-party platforms like OpenRouter, proving that reduced prices do not signal an end to demand but rather stimulate its expansion. This paradox suggests that cheaper AI intelligence can transform into a "General Purpose Technology," driving long-term economic growth by redefining efficiency.

💡For an expansionary economic environment, recommended investment strategies emphasize diversification and flexible sector positioning due to broadening earnings growth and increased sector rotation. While technology remains a core allocation, investors should focus on technological leadership, monetization speed, and ecosystem integration capabilities within AI, rather than just pricing-up beneficiaries. The portfolio should balance offensive sectors, which benefit when risk appetite rises, with defensive allocations, which demonstrate resilience during cautious market sentiment. This approach moves beyond betting on single narratives, ensuring a more balanced and adaptable strategy amid market volatility and spreading earnings momentum.

💡The market's capital rotation has led to improving earnings for the other 493 S&P 500 companies, significantly broadening earnings growth beyond the M7-dominated performance of the past two to three years. This shift is evident even as the Philadelphia Semiconductor Index fell by nearly 30% in less than two months, with the S&P 500 reaching new highs, indicating capital has rotated from previously strong areas like semiconductors and hardware into other sectors. This trend aligns with an expansionary economy where earnings growth spreads from leading companies to the broader market, diversifying performance across industries.

💡As of August 7, 2026, the updated guidance for S&P 500 EPS in Q3 2026 is largely positive, with approximately 67% of the 75 companies that provided guidance issuing positive outlooks. This figure significantly exceeds the five-year average of 42% and the 10-year average of 40%. This widespread optimism in corporate outlooks indicates confidence in continued earnings momentum and aligns with the broader trend of expanding earnings growth across various sectors, suggesting a robust outlook for the upcoming quarter.

💡Several specific companies demonstrated strong AI monetization in their Q2 results. Amazon AWS, Microsoft Intelligent Cloud, and Google Cloud reported robust revenue growth of 37%, 32%, and 82%, respectively, indicating that AI infrastructure investments are entering a harvest phase. SpaceX announced its AI division's adjusted EBITDA turned positive at $1.1 billion. In software, Palantir's Q2 revenue hit a record $1.94 billion, up 93% YoY, and Cloudflare noted a more than 1,700% increase in daily AI Agent requests, showcasing tangible AI-driven revenue and cash flow conversion.

💡Oil prices in Q2 2026 significantly boosted the Energy sector's earnings growth, reaching 147.0% year-over-year. The average oil price rose 45% to $92.55 per barrel compared to $63.68 in the same period last year, primarily driven by the US-Iran conflict. This surge in oil prices directly supported substantial growth in the refining and oil and gas exploration industries, making Energy a primary growth engine for the S&P 500 in Q2.

💡Investment banking fees played a crucial role in the Financials sector's Q2 performance, contributing to its 21.0% earnings growth and 11.7% revenue growth. Strong financing demand, largely driven by AI development, fueled a wide range of activities including large M&A transactions, IPOs, and equity and debt underwriting. Specifically, investment banking fees at Goldman Sachs and J.P. Morgan increased by 55% and 30% year-over-year, respectively, reflecting robust activity and demonstrating the sector's benefit from capital market engagements tied to technological advancements.