NEW YORK, May 6 (Reuters) - A humming U.S. corporate profit engine is at the heart of the U.S. stock market's rally to record highs - an encouraging sign for investors as long as the fuel driving profits keeps flowing.

More than two-thirds through the first-quarter reporting season, S&P 500 companies are on track for their highest quarterly earnings growth in more than four years. Future projections are also growing rosier: Analysts' estimates for future 12-month U.S. earnings have risen by over 10% since the start of the year, according to LSEG Datastream.

As some of the worst-case economic fears tied to the war in Iran have receded, investors said Wall Street has been able to focus on the earnings strength, helped by massive investments in artificial intelligence technology and a generally solid economic backdrop.

"Because things have not gotten worse and the ceasefire has been in place for some time now, it's been earnings that have driven the move higher," said Chris Fasciano, chief market strategist at Commonwealth Financial Network.

The benchmark S&P 500 is up 6% for the year, building on three straight years of solid double-digit percentage gains. The index has surged more than 14% since March 30, following a swoon sparked by the start of the U.S.-Israeli war with Iran.

STRONGEST QUARTER IN 20 YEARS?

Investors had expected generally solid results when the reporting season kicked off last month, but they have far surpassed expectations. S&P 500 earnings are expected to have jumped 28.2% in the first quarter from a year earlier, including results from 350 index companies that have reported and analysts' estimates for those yet to report, according to data as of Tuesday from Tajinder Dhillon, head of earnings and equity research at LSEG Data & Analytics.

That increase would be the highest since the fourth quarter of 2021, when businesses were recovering from pandemic lockdowns.

"Excluding special factors like favorable base effects and corporate tax cuts, earnings growth is arguably the strongest in two decades," Binky Chadha, chief U.S. equity strategist at Deutsche Bank, said in a note.

Projections for the rest of 2026 are also rising. S&P 500 earnings are expected to jump 22.6% for the full year 2026, with estimates higher for each of the next three quarters than they were on April 1, according to LSEG IBES.

Companies still to report this period include semiconductor giant Nvidia, major retailers including Walmart and Home Depot, and software company Salesforce.

NOT JUST AN AI BOOST

The massive investments by technology companies to support AI applications is a key factor supporting U.S. profits. Five AI hyperscalers are expected to lay out $751 billion in capital expenditures in 2026, according to Goldman Sachs strategists, as the companies pour resources into data centers and other infrastructure.

Companies and industries that are AI beneficiaries have increased first-quarter earnings by 50%, Deutsche Bank said in a report on Monday, including semiconductor companies and other tech hardware firms, as well as electrical equipment and construction companies.

AI has been "a tree that spreads a lot of limbs out," said Chuck Carlson, CEO at Horizon Investment Services. "That spending that is going on in that space is really a pretty significant driver."

Investors also point to broadly solid earnings amid a stable economic backdrop. Median company earnings growth has been 12.2%, according to Deutsche Bank, while Morgan Stanley strategists note the median S&P 500 company earnings surprise is the strongest it has been in four years. Nine of the 11 S&P 500 sectors are on pace for higher first-quarter earnings, with eight each up at least 10%, according to LSEG IBES.

Companies are showing they can weather the war-related energy price surge that has sent oil prices over $100 a barrel, said Keith Lerner, chief investment officer at Truist Advisory Services.

"It's definitely hurting some businesses, but companies have gone through so many shocks, they are more equipped to just be able to be agile when these things happen," Lerner said.

MARKET VALUATION MODERATES AS EARNINGS RISE

The strength in earnings has helped stocks rise even as the market's valuation has moderated. While still well above its long-term average of 16, the S&P 500's price-to-earnings ratio was at 21.2 times expected 12-month earnings, according to LSEG Datastream. That is down from the 23.5 level it reached in late October.

Markets are no longer pricing in equity-friendly rate cuts this year, amid energy-driven higher inflation, pressuring stock valuations and raising the stakes for strong earnings growth.

As investors weigh the likelihood of earnings staying strong, they will be watching the AI theme and any signs of pullback from the leaders in the field.

The Middle East war remains at the forefront for investors, who worry about more significant fallout for businesses and consumers the longer the conflict goes on and keeps energy and other prices elevated.

"For the moment, I think investors are willing to sort of ride the wave of strong earnings and generally decent economic news," said Robert Pavlik, senior portfolio manager at Dakota Wealth Management. "Eventually, $4.50-a-gallon gasoline is going to catch up to the economy, you would imagine."