Hedge funds are increasingly scrutinising elevated US corporate earnings expectations as Wall Street analysts lift S&P 500 profit forecasts at the fastest pace since the post-pandemic recovery, raising concerns that markets may be pricing in overly optimistic assumptions, report by the FT.

Consensus estimates now call for around 25% earnings growth over the next 12 months, driven by resilient economic growth and continued AI investment. However, investors warn that expectations for semiconductor and hyperscale technology companies have become increasingly demanding ahead of second-quarter earnings season.

Ben Inker, Co-Head of Asset Allocation at GMO, said forward earnings estimates have risen at a pace rarely seen outside economic recoveries, leaving little room for companies to disappoint. Capital Economics also cautioned that AI-related earnings and capital expenditure assumptions may be difficult to sustain, increasing the risk of a broader equity market pullback.

For hedge funds, the focus is shifting from earnings growth to the market's ability to absorb any guidance misses. With the S&P 500 trading at around 20x forward earnings, even modest disappointments could trigger sharp sector rotations, particularly across AI-linked names that have led this year's rally.

Kasper Elmgreen, CIO for Fixed Income and Equities at Nordea Asset Management, said the market's margin for error has narrowed significantly, with investors now watching closely to see whether companies can continue exceeding increasingly ambitious expectations.