Wall Street may be significantly underestimating the explosive power of the current earnings cycle.

In a September 14 research report, Jefferies issued a clear warning: don't fight the earnings cycle. Driven by the twin engines of the AI investment frenzy and better-than-expected corporate earnings growth, the S&P 500 is projected to surge to 8,000 points by the end of this year (2026) and reach 9,000 in 2027.

The report argues that despite macro headwinds such as rising 10-year Treasury yields, sticky inflation, and midterm elections, corporate fundamentals will remain the core driver of returns.

Jefferies' core logic is clear and compelling: in a cycle where earnings growth is more than twice the historical average, fighting the earnings trend is dangerous.

Additionally, Jefferies believes that AI-driven earnings expansion is spreading from the "Magnificent Seven" to the broader market, providing a stronger foundation. The firm advises focusing on overweighted sectors such as technology, financials, healthcare, and materials that have strong earnings revisions and macro support, seizing this rare earnings super-cycle amid concerns about valuation compression.

However, the report also highlights two core risks: first, a substantial slowdown in earnings growth for AI-related companies, which would directly undermine the foundation of the entire bull market thesis; second, the continued rise in 10-year Treasury yields, which could exert systemic pressure on equities through the valuation compression channel.

Earnings Expectations Severely Underestimated, S&P 500 Targets 8,000

Jefferies' base case is highly aggressive and entirely earnings-driven.

The report sets a year-end 2026 target of 8,000 for the S&P 500, based on earnings per share (EPS) of $373 (up 35% year-over-year, well above the consensus of 29%) and a price-to-earnings multiple of 21.5x. For 2027, the base case projects the index at 9,000, based on EPS of $450 (up 20.8%) and a 20.0x P/E ratio.

In the most bullish "bull" scenario, the S&P 500 could even break through 10,500 in 2027 (EPS of $500, up 34.2%); in a "bear" scenario with a significant earnings slowdown, the index could fall back to 6,900.

The firm's core argument is that the market is pricing in five consecutive years of double-digit, above-average returns for the S&P 500, a feat only seen during the late-stage tech boom of 1995-1999 since 1970.

As long as earnings expectations remain strong, current valuation levels (weighted model at the 76th percentile) are manageable.

AI Remains the Core Engine, but Market Breadth Is Expanding Significantly

The report's central thesis is that the market systematically underestimates the power of the earnings cycle, and the upside revision potential remains significant.

Jefferies argues that the core of the earnings story is still artificial intelligence, but it is no longer exclusive to a handful of giants. Data shows that approximately 46% of the S&P 500's weight has direct or indirect exposure to AI and data center spending. Earnings for these AI-related companies are projected to surge 60% this year, slowing to 24% by 2027.

Meanwhile, market breadth is improving markedly. While the "Magnificent Seven" is expected to deliver 45% earnings growth in 2026, the earnings expectations for the rest of the S&P 500 have also improved substantially to around 24%. By 2027, more than 40% of S&P 500 constituents are expected to see accelerating earnings.

Jefferies believes that this cross-industry upward revision in earnings and sales expectations indicates that fundamentals are becoming healthier and more diversified.

"Magnificent Seven" Faces Rotation Pressure, but Valuations at Multi-Year Lows

Although the "Magnificent Seven" still accounts for about 33% of the S&P 500's weight, the environment driving their outperformance is becoming more complex. Due to record AI investment, the "Magnificent Seven" now accounts for approximately 40% of total S&P 500 capital expenditures (up from just 16% in June 2023). This has turned free cash flow (FCF) negative for hyperscalers, and it is not expected to recover until 2028. Additionally, earnings growth for this group is projected to slow from 45% in 2026 to 17% in 2027.

However, for contrarian investors, the good news is that valuations for the "Magnificent Seven" have been significantly reset. On an absolute basis, the group is currently at the 43rd percentile, the lowest level since January 2023; relative to the rest of the S&P 500, its relative valuation has plunged from the 98th percentile a year ago to just the 9th percentile today.

Macro Headwinds: 10-Year Treasury Yields and Fiscal Deficit Are the Biggest Tail Risks

On the Federal Reserve front, the market currently prices in an approximately 85% probability of a rate hike in September and about an 83% probability of another hike before January 2027, but the terminal rate is only about 50-75 basis points higher than current levels. Jefferies economist Tom Simons takes a contrarian view, believing the Fed may not need to raise rates this year and expecting policy expectations to shift toward rate cuts during the year.

The firm believes that the real macro threat is not the Fed's short-term actions but long-term borrowing costs. History shows that when the 10-year Treasury yield rises more than 100 basis points over a 12-month period, the P/E multiple typically contracts by at least 1x (yields have already risen more than 60 basis points this year).

The deeper crisis lies in the deteriorating fiscal situation: U.S. national debt has surpassed $40 trillion, and total debt servicing costs have surged from approximately $350 billion to over $1.1 trillion over the past five years, now rivaling annual defense spending.

The Congressional Budget Office projects the federal deficit to reach approximately $1.9 trillion in 2026 and grow to about $3.1 trillion by 2036. This sustained deficit spending and massive issuance of long-dated Treasury debt will put upward pressure on long-term yields, potentially forcing further valuation compression.

Navigating Inflation and Elections: Historical Data Reveals a "Safe Haven"

In the face of sticky inflation and the upcoming midterm elections, there is no need for excessive panic.

On inflation, the report argues that the current environment is more similar to the late 1980s/early 1990s and mid-2000s than to the "Great Inflation" era of the 1970s. Historical data shows that during these two analogous periods, the S&P 500 delivered average annual returns of approximately 17% and 15% respectively, with investors still earning substantial returns even when inflation ran above target.

On the political front, prediction markets indicate a high likelihood of a "divided Congress" following the midterm elections (87.5% probability of Democrats controlling the House and 47.5% probability of Republicans retaining the Senate), with a divided government being the most likely outcome.

Jefferies believes that historical data indicates legislative gridlock often reduces policy uncertainty, which is a positive for risk assets. In the year following midterm elections, the S&P 500 has delivered an average return of 13%.

Historical data since 1978 shows that in the 12 months following midterm elections, the S&P 500 has averaged a 13.1% return, with the median also at 13.1%, both significantly above the historical average. The strongest-performing sectors after elections are typically technology, consumer discretionary, and materials.