The Market is Being Paid for AI Earnings, but Charged for Inflation Risk
Corrado Tiralongo - 16 juin 2026
The market is being paid for AI earnings, but charged for inflation risk
The market is still being paid to believe in AI earnings growth. It is also starting to be charged for inflation risk again. That is a harder combination than it looks.
The AI earnings cycle remains powerful. U.S. equity markets have not been rising on enthusiasm alone. Earnings growth, particularly among the largest technology and AI related companies, has done much of the heavy lifting. But inflation risk is rebuilding at the same time. Labour markets are proving more resilient than expected, energy prices are still working through the data, and central banks may not have as much room to look through this shock as investors assumed even a few weeks ago.
This is the market’s central problem. AI supports the growth story. Higher real yields challenge the valuation story.
Those two forces can coexist for a while. They may not coexist comfortably if inflation keeps moving higher and central banks have to respond. The issue is no longer whether AI is real. The issue is whether the earnings path is strong enough to absorb a higher discount rate.
Inflation is moving in the wrong direction
The next phase of the inflation cycle is unlikely to look as benign as the last one.
U.S. inflation is expected to move back above 4%, with core inflation also drifting higher. For now, the pressure is concentrated in energy linked categories such as gasoline and airfares. But core inflation moving back toward 3% is not a comfortable backdrop for the Federal Reserve, especially when the labour market is not weakening in the way many expected.
The latest U.S. payrolls report matters for that reason. Strong job growth in the middle of an energy shock changes the policy discussion1. It suggests the economy may be able to absorb tighter policy, or at least that the Fed may believe it can.
Central banks are being asked to solve the wrong problem
The current inflation shock is not a classic demand shock.
Central banks know how to deal with excess demand. They raise interest rates, cool spending, loosen the labour market and reduce inflation pressure. The problem today is different. Recent inflation shocks have come mainly from the supply side: COVID, Russia’s invasion of Ukraine, tariffs, and now the closure of the Strait of Hormuz.
Interest rates do not reopen shipping lanes. They do not produce oil. They do not lower tariff barriers. They do not solve geopolitical fragmentation.
What higher rates can do is protect inflation expectations. That is why central banks may still lean hawkish even if they know rate hikes are a blunt instrument.
Canada is not in recession, but it is not in a clean expansion either
Canada adds an important nuance.
The earlier GDP data made the economy look as though it had slipped into a technical recession. That likely overstated the weakness, but it did not eliminate the concern. The May labour market data were much stronger than expected, with employment rising by 87,800 and the unemployment rate falling to 6.6% from 6.9%2.
Wage growth slowed to 3.0% year over year from 4.5%, which gives the Bank some comfort. But a stronger labour market, combined with rising input prices, keeps the risk of second round inflation effects alive.
Tariffs are back, but the bigger issue is CUSMA
Tariffs are no longer the dominant market story, but they have not disappeared.
The latest tariff proposal would include a 10% tariff on Canada tied to forced labour import enforcement4. At face value, the direct economic impact may be limited because CUSMA compliant goods would still be exempt.
Europe’s challenge is more acute
Europe looks more vulnerable than North America.
The euro-zone economy is being hit by the energy shock at a time when business surveys already point to a stall in activity. Inflation is expected to rise further, with headline inflation forecast to peak around 3.5% and core inflation around 2.5%5.
The U.S. still has the growth advantage, but AI is carrying more weight
The U.S. economy remains in better shape than most other developed markets. A major reason is the investment boom around artificial intelligence.
AI related investment has become a meaningful contributor to U.S. growth. Without that impulse, U.S. growth would look materially less impressive.
Earnings have justified more of the rally than valuations alone suggest
It is easy to say U.S. equities are expensive. It is harder to say the rally has been purely speculative.
Forward earnings in the large technology companies have more than doubled since the AI cycle began in late 2022.
Good news can become bad news when discount rates rise
A stronger economy is usually good for equities. Not always.
When inflation is rising and central banks are becoming more hawkish, strong economic data can push yields higher and weigh on equity valuations.
The market’s problem is not current earnings. It is the expectation of uninterrupted earnings growth
The most important risk to this rally is not that AI suddenly disappears. It will not.
The risk is that the revenue path becomes less linear than investors expect.
Canada Life Investment Management portfolio implications
We are not treating this as a reason to step away from risk. We are treating it as a reason to be more deliberate about which risks we own.
Final thought
The rally can continue.
But the market now needs more things to go right at the same time.
Inflation is moving higher. Central banks are becoming less comfortable. U.S. labour market strength makes Fed hikes more plausible. Canada is not as weak as feared, but the Bank of Canada cannot ignore second round inflation risk. Europe is dealing with the harder combination of weak growth and rising prices. Tariffs and CUSMA uncertainty are adding another layer of friction.
The equity market is increasingly reliant on the assumption that AI related earnings can continue to grow at an exceptional pace.
That may prove right.
But when investors become emotionally attached to a narrative, evidence stops being evidence. The AI story may still have room to run, but from here, enthusiasm alone is not enough. Earnings have to keep confirming the story.
Corrado Tiralongo (he/him)
Vice President, Asset Allocation & Chief Investment Officer
Canada Life Investment Management Ltd.