Stocks That Became Hot Bets on Artificial Intelligence

This spring, an unexpected star has emerged in the stock market, standing out even in a year full of surprises on Wall Street. Utilities—the usually unremarkable sector—are outperforming the competition.

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The recent rise in power company shares is partly a rebound from a challenging 2023. However, it also signals increasing confidence that the U.S. economy can withstand higher interest rates and turn the potential of artificial intelligence into a reality.

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Recent data has shown a cooling in job growth and a gradual slowdown in inflation, without significant economic decline. This has positioned power generators, who are expected to supply the energy for AI-driven data centers, as a strategic investment linked to the anticipated tech boom.

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The typically steady utility sector of the S&P 500 has risen by 18% over the past three months, outpacing the energy industry, which climbed 11%. Notably, three of the top five performers in the index this year are power producers. Texas-based Vistra’s impressive 138% surge in 2024 even overshadows Nvidia’s celebrated 91% increase.

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Despite this performance, few investors believe that power stocks, known for their steady dividends, will reach the high price/earnings ratios of chip makers and large tech companies focused on AI. However, on Wall Street, there is a growing belief that the sector will benefit from new data centers driving a significant increase in U.S. electricity demand for the first time in decades.

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“That’s where the puck is going,” said John Bartlett, president of Reaves Asset Management. A long-time utility investor, Bartlett now closely monitors the development plans of cloud-computing giants like Alphabet, Amazon, and Microsoft, which are investing billions in AI.

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“Those are the people that you really need to pay attention to regarding electricity demand,” he added.

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According to Citi analysts, data centers could account for 10.9% of U.S. electricity demand by 2030, up from 4.5% today. If power needs grow as expected, it will mean more plants, transmission lines, and infrastructure—translating to higher returns for the companies building them.

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The rise in utility stocks represents a reversal from last year when the Federal Reserve’s interest-rate hikes made high-yield investments like Treasurys more attractive, pulling investors away from utilities and their reliable dividends.

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Although this dynamic persists—utility dividends still offer less income than government debt—more traders are now turning to the sector. This shift follows optimistic projections from tech analysts and power providers about increasing electricity demand in the future, transforming power companies from defensive stocks into a surprising growth investment.

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The rally began with independent power producers selling electricity in wholesale markets and has since spread to regulated utilities. However, analysts caution that companies less involved with data centers or those manufacturing grid equipment may not benefit as much. There's also a risk that the U.S. economy might slow down or AI enthusiasm might fade before utilities can capitalize on the expected growth in demand.

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“Nothing in the world of electric power is a sprint,” said Pavel Molchanov, an analyst at Raymond James.

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Long-term, higher electricity prices or dirtier power generation could provoke regulatory backlash. In states like Georgia, utility plans to build new fossil-fuel plants have faced opposition from consumer groups and climate advocates. If the projected growth in power demand doesn't materialize, critics warn that ratepayers could end up with higher costs for decades.

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“The risk is always that this build-out is very inflationary,” said Jim Lydotes, deputy chief investment officer of equities at Newton Investment Management. “It’s going to have to come on the backs of consumer bills.”

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As more utilities propose new construction, the tension between ratepayer concerns and shareholder returns could increase. Regulators might limit utility returns, diminishing the investment appeal of companies that will need to issue stock to fund projects.

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“The utilities are going to have to self-fund this growth,” Lydotes said. “The regulators have to keep returns acceptable.”

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