As the U.S. stock bull market approaches its fourth anniversary, how much longer can the S&P 500's "AI dependence" hold up?

As the U.S. stock bull market approaches its fourth anniversary, how much longer can the S&P 500's "AI dependence" hold up? The U.S. stock market's bull run is showing few signs of stress as it approaches its fourth anniversary: corporate profits are rock-solid, the S&P 500 is near record highs, and volatility appears relatively subdued. But beneath the surface, questions are mounting about what could end this rally, which began on October 12, 2022, and has gained 117% so far. While there is no single answer, one increasingly prominent point of contention is the massive divergence between an index trading at record highs and the lackluster performance of many individual stocks. Compiled data shows that since October 2022, the equal-weighted S&P 500, which strips out market-cap weighting effects, has lagged the benchmark index by 52 percentage points the most extreme strength gap at this stage of a bull market since at least the 1990s. Ned Davis Research (NDR) also noted in a report published before the S&P 500 hit a fresh record high on Tuesday that in the week of September 21, fewer than 25% of constituents were trading above their 50-day moving averages, and the proportion of stocks trading above their 200-day moving averages also fell below 45%. NDR characterized this combination of "the index nearing record highs while market breadth deteriorates sharply" as the worst breadth reading on record. Also worth noting is that the simultaneous occurrence of three conditions fewer than 35% of stocks above their 50-day moving average, fewer than 50% above their 200-day moving average, and the S&P 500 within 3% of a record high has occurred only six times since 1980. In previous instances when similar signals appeared, the market reached an interim top within about five months. NDR Chief U.S. Strategist Ed Clissold and Senior Analyst Thanh Nguyen explicitly stated: "The vast majority of market tops are preceded by breadth divergence. We take this technical warning signal seriously." "This bull market will continue but my concern is that compared with history, the breadth of this rally is too narrow," said Sam Stovall, Chief Investment Strategist at CFRA. "One day this rally will end, but it will all depend on the outlook for U.S. corporate profit growth." According to CFRA data going back to 1947, the S&P 500's 117% gain since 2022 ranks third among bull markets at the four-year mark. Data shows that when a rally extends into its fifth year, the average gain is 21%. In theory, this means there is room for the rally to broaden beyond the tech giants which have contributed the vast majority of gains since October 2022. Concentration itself is not the problem; when earnings are similarly concentrated, this configuration has its rationale the top ten companies contribute about one-third of the index's earnings, broadly in line with the trend in market-cap concentration over the past decade. However, the risk is that when valuations are already "priced to perfection" and any shift in market sentiment could trigger a chain selloff of concentrated positions, the portfolio's fragility will far exceed investors' expectations. The core narrative of this bull market is undoubtedly artificial intelligence. Since U.S. stocks bottomed in late 2022, the AI boom has added nearly $40 trillion in market value to the S&P 500 (AI). As the flagship company of the AI trade, chipmaker NVIDIA Corporation (NVDA.US) has surged more than 1,900% since the late-2022 bottom and is about to become the first company to reach a $6 trillion market cap. However, with the stock market so highly tied to AI optimism, this setup is vulnerable to violent swings if the wind changes. When and whether Wall Street will see returns from the billions of dollars invested in AI infrastructure remains unknown. UBS Group AG estimates show that global hyperscaler capital expenditure will climb from about $1 trillion in 2026 to about $1.45 trillion in 2027, totaling approximately $4.1 trillion cumulatively from 2026 to 2028. Yet revenue realization lags severely according to IDC forecasts, the global generative AI market will approach $150 billion in 2027, still a huge gap compared with trillion-dollar-level capital expenditure. FactSet data shows that hyperscalers' incremental debt as a share of capital expenditure has risen from 9% in fiscal 2024 to 32% by mid-2026, and the free cash flow of the five largest hyperscalers has approached zero or turned negative in 2026. Beyond that, another peculiarity of this bull market is its misalignment with the monetary policy cycle. Jurrien Timmer, Global Macro Director at Fidelity Investments, said traditional bull markets typically feature broad-based gains in their early years because the Federal Reserve cuts rates to support the economy. But this time it was the opposite: the Fed raised rates in 2022 to curb inflation, and after the most aggressive monetary tightening in decades, this pressured stocks and forced companies to lower profit expectations. Amid the interplay of these risk factors, the continued strength of corporate earnings constitutes the most core support for the current bull market. Today, U.S. companies are experiencing one of the strongest earnings cycles in modern history, with the S&P 500 delivering double-digit earnings growth for seven consecutive quarters. Investors expect this momentum to continue. "As long as companies keep delivering good results, investors will continue to ignore most of the risks," Timmer said. "But once any signs of weakness appear, the market will scrutinize valuation levels." The third-quarter earnings season kicks off next Tuesday, with major banks including JPMorgan (JPM.US) among the first to report, which will be a major test for the stock market. Subsequently, the U.S. midterm elections in November could trigger short-term volatility. And the Fed's rate path remains a major variable in the outlook. Despite all these risks, the S&P 500 is currently still not far from 8,000. Long-term bull Ed Yardeni, President of Yardeni Research, expects the S&P 500 to reach 10,000 by the end of this decade, supported by strong corporate profits and a solid economy. However, he lowered his year-end S&P 500 target last month from 8,400 to 7,900, saying the risk of an economic downturn over the next three to six months has risen. So where is the problem? Rising yields are a major headwind. The 10-year U.S. Treasury yield rose to 5.34% last week, the first time since 2002, dealing a severe blow to everything from rate-sensitive small-caps to banks, and to the market's more speculative corners such as unprofitable tech companies and the most fragile balance sheets. Another reason for bullish optimism is the resilience of the economy, with investors shaking off recession fears, which helped valuations recover after 2022. The Atlanta Fed's GDPNow model projects third-quarter real GDP growth at a 3.7% annualized rate, up from 2.2% in the second quarter. That is why Seth Merrill, Managing Director and Chief Investment Officer at Melody Global, believes the Fed's gradual rate hikes this cycle may create conditions for market rotation and more sectors to take over leadership. "In my portfolio, assets outside the mega-cap tech names have delivered flat or even poor returns," Merrill said. "But at the index level, you would never know it."