Utilities have traditionally been known for their defensive properties, which makes the combination of robust economic growth, technological excitement and elevated bond yields an unlikely recipe for their outperformance.
While attention has been focused on AI and the hyperscalers, a new wave of energy demand has created an unlikely market leader year-to-date: utility stocks. The continued increase in data, compute, cloud migration and now, AI, have fueled growth in data centers and the electricity needed to power them up, providing a powerful catalyst for many companies along this value chain.
Utilities have traditionally been known for their defensive properties, which makes the combination of robust economic growth, technological excitement and elevated bond yields an unlikely recipe for their outperformance. Whereas the market is up 20% year-to-date, utilities have returned 25% in total return, the second-best performing sector behind tech. Indeed, the top performing stock this year is no longer the famous chip designer but a Texas-based energy company.
What explains this recent performance?
For starters, the U.S. electric grid is in great need of modernization. With its origins dating back to the late 1800s, the electric grid has improved and expanded over the years, but much of the recent investment has been on efficiency gains as opposed to new generation capacity or grid updates. “If it ain’t broke, don’t fix it” has left the U.S. with an aging infrastructure that is vulnerable to climate risks and unprepared in the face of new AI demand.
After 20 years of flatlining power demand, U.S. power needs have reached an inflection point. AI technologies are very power intensive1 and the race to adoption has underscored the need for sufficient and reliable power supply. Data centers currently consume 4.5% of U.S. power supply and estimates suggest this could grow to 8% or above by 2030. Increased electric vehicle usage and reshoring of manufacturing have added further demands to the grid, while an increased frequency of extreme whether events have increased the risk of blackouts during peak-demand periods.
For the right companies, this backdrop poses significant advantages. As our U.S. equity growth team outlined in a recent piece, companies involved in renewables and storage, traditional power generation, grid expansion and renewal, and electrical infrastructure upgrades all stand to benefit. An active approach remains important because after all, new demand does not equate to new profits. Companies with cash on hand to invest, pricing power, and the ability to adapt and respond quickly to new demand stand to benefit the most.
Pricing is also a consideration, and broad valuations for utilities remain attractive despite recent performance. At 18.7x next 12-month earnings, the sector is trading at a 13% discount to the S&P 500 and is only slightly above its own 5-year and 10-year averages. Falling interest rates could provide a further boost for the sector as their dividend yields become relatively more attractive and stronger long-term earnings growth could justify further upgrades in their valuations. For investors looking to diversify tech exposure, utilities could provide an attractive way to invest in the infrastructure buildout underway, with a very different wrapper.